What is Bid-Ask Spread? (Plain English Definition)
Definition: The bid-ask spread is the difference between the highest price a buyer will pay and the lowest price a seller will accept for a security.
Bid-Ask Spread Explained Simply
The bid-ask spread is the gap between the bid price (the most a buyer is willing to pay) and the ask price (the least a seller is willing to accept). This spread represents a hidden cost of trading that does not appear as a fee on your statement. Every time you buy an ETF at the ask and later sell at the bid, the spread works against you.
For heavily traded ETFs like SPY, the bid-ask spread is typically just one penny per share. For less liquid ETFs, especially those focused on niche sectors, international markets, or alternative asset classes, the spread can be much wider -- sometimes 10 to 50 cents per share or more.
The spread is influenced by several factors: trading volume, the number of market makers, the liquidity of the underlying securities, and the time of day. Spreads tend to be widest at the market open and close, and tightest during the middle of the trading day when liquidity is highest. The underlying assets also matter -- an ETF holding frequently traded U.S. large-cap stocks will have a tighter spread than one holding illiquid emerging market bonds.
Bid-Ask Spread Example
You want to buy 500 shares of an ETF. The bid is $25.00 and the ask is $25.05, a spread of $0.05. When you buy at $25.05, you immediately "lose" $0.05 per share compared to the mid-point price. That is $25 in hidden costs on this one trade. If you frequently trade an ETF with a $0.10 spread, buying and selling just once costs you $0.20 per share in spread costs alone.
Why Bid-Ask Spread Matters for ETF Investors
The bid-ask spread is an often-overlooked cost that can significantly impact ETF investors, especially those who trade frequently or invest in less liquid funds. While expense ratios are the most discussed cost, the spread can actually matter more for short-term traders. ETF investors can minimize spread costs by sticking to high-volume ETFs with tight spreads, using limit orders instead of market orders, and avoiding trading during the first and last 15 minutes of the trading day when spreads tend to widen. For long-term buy-and-hold investors, spreads matter less since you only pay them when entering and exiting positions.
Bid-Ask Spread vs Liquidity
| Bid-Ask Spread | Liquidity |
|---|---|
| The bid-ask spread is the difference between the highest price a buyer will pay and the lowest price a seller will accept for a security. | See full definition of Liquidity |
While bid-ask spread and liquidity are related concepts, they serve different purposes in the world of ETF investing. Understanding both terms helps you make more informed decisions about which funds to include in your portfolio and how to evaluate their performance.
Related Terms
Deepen your understanding of ETF investing by exploring these related concepts:
Liquidity
Liquidity refers to how quickly and easily an investment can be bought or sold without significantly affecting its price.
Ask Price
The ask price is the lowest price at which a seller is willing to sell a security, representing the cost to buyers.
Bid Price
The bid price is the highest price a buyer is currently willing to pay for a security.
Market Order
A market order is an instruction to buy or sell a security immediately at the best available current price.
Limit Order
A limit order is an instruction to buy or sell a security at a specific price or better, giving you control over the execution price.
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