What are bid and ask prices?

Bid and ask prices refer to the prices that a person is willing to purchase a stock or the price a person is willing to sell a stock. There is always a little variance between what the seller wants to sell at and what the buyer is willing to pay. This difference in prices is what is known as the spread.

The stock exchange is more like a flea market than centers of financial sophistication when it comes to actually buying and selling shares of stock. That is why you must understand the dynamics of the bid and ask prices.

Both the buyer and the seller have influence on the prices set for stock. In a retail store, the seller sets the price and the buyer must decide whether they are willing to pay that price. However in the stock market, the buyer states what price they will pay for the stock - this is the bid price. The seller also has a price - the ask price.

The role of the stock exchanges is to facilitate the trading of stock. This means they want to make the bid and ask prices match up as much as possible. This service does not come without a price.

You may find access to the stock prices through several different methods. Online is probably the quickest and most accurate. This is because you can get up to date information. The newspaper is probably one of the worst places to find stock quotes. Online you may also be able to find the bid and ask prices. The NASDAQ structures its prices around the bid and ask prices.

You will notice that the bid price and the ask price are never the same. The ask price is always a little higher than the bid price. What this means is if you are buying the stock you pay the ask price (the higher price) and if you are selling the stock you receive the bid price (the lower price).

Now you may ask, `what happens to the difference between the two prices?' This difference is the spread and it is kept as profit by the broker/specialist handling the transaction. The spread goes to pay for a number of fees in addition to going to the broker. However, this is not the same commission you pay a retail broker. The spread is built into the transaction and you will still pay your broker a fee on top of the spread.

If trading gets too lopsided - everyone wants to sell and no one wants to buy - the exchange may stop trading for what's called an "order imbalance,". This can cause the spread to become too large for any trades to take place. This is usually caused by a piece of very good or bad news about the stock - or even a rumor being passed around by traders. After everyone's had a chance to digest the news, trading starts up again at a different price and (usually) things go smoothly again.

This new information could cause a situation where your broker is unable to find a seller for your order of stock. However, the order imbalance is usually only temporary and then you are able to complete your order as desired. You may find that the news has changed the stock price though and nobody is willing to sell to you at the price you originally wanted. You may have to raise the price you are willing to pay.

The opposite is true also. The news may have been bad and now you are able to get the stock at a better price. However, if the stock is really bad, you may want to evaluate whether you want to purchase the price.

After everyone has had a chance to evaluate the information, trading should resume. If there are more sellers than buyers, then the price is too high. The price should move down until a price is found that has similar buyers and sellers. If there are more buyers than sellers, the price will move up in a similar fashion. Eventually, a price will be found that has equivalent buyers and sellers and trading will resume normally.

If there is a spread - the seller wants more than the buyer is willing to pay - then the trade won't take place in theory. However, on the New York Stock Exchange, the people matching trades are supposed to dip into their own pocket, if necessary, to match trades. This will help keep the volume moving in a slow market.

In summary, the ask and bid prices refer to what the seller and buyer are willing to make the trade at. The difference between them is referred to as the spread. If you are buying you will pay the asking price and if you are selling you will get the bid price. The spread goes to the broker and other fees.