How Bid-Ask Spreads Create Trading Costs for Market Orders
Summary
The document explains the bid-ask spread as the gap between the best prices buyers will pay and sellers will accept. A market order to buy generally executes at the ask, while a market order to sell generally executes at the bid. The difference creates an immediate trading cost for someone who buys and then quickly sells, even when the quoted market price appears unchanged.
A numerical stock example shows this round-trip effect: buying at the ask and reversing at the bid loses the spread. The response contrasts market orders with a limit buy placed inside the spread; if matched with a seller's market order, it can execute at a better price than the ask. This example illustrates potential savings, but a limit order may not execute, and the spread does not necessarily accrue entirely to a market maker in every market or trade. The discussion focuses on price impact from the quote and does not quantify commissions or other execution costs.
Key ideas
- The bid is the best quoted buying price, and the ask is the best quoted selling price.
- Market buyers generally pay the ask, while market sellers generally receive the bid.
- A rapid buy-then-sell round trip at unchanged quotes incurs the bid-ask spread.
- A limit order inside the spread may improve the execution price if it finds a counterparty.
- The example omits execution uncertainty and costs beyond the spread.
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# How brokers' spread costs work? # How brokers' spread costs work? I am trying to understand how to size and compare brokers' costs. As per my understanding, they charge customers on either or both spreads and commissions. The latters are straightforward: for each contract a percentage/a fixed amount has to be paid to the broker (two times per round trade, i.e. when entering and when exiting the position): - buying and selling 1 share at 100\$ with 1% commission would result in 2\$ total commissions - buying and selling 1 ES contract (value 50\$) with fixed commission of 3\$ would result in 6$ total commissions Instead, I cannot get how spread costs work. Can please someone explain the rationale, possibly with numeric examples as above? P.S.: please also advise whether something above is not correct ## Answer by Andreas (score 1) https://quant.stackexchange.com/a/53382 The spread, or Bid-Ask spread indicates the difference between the prices which market participants are willing to sell at (Ask) and willing to buy at (Bid). If you are selling without any specific instruction (i.e. place a market order at the best possible price), you are going to get the bid price, if you are buying, you are going to do so at the ask price. Assume the following about a stock: Bid 99.50 - 100.50 Ask In case you want to buy 1 share, you're going to have to pay 100.50 (Ask). If after a moment you'd change your mind, you'd only get 99.50 (Bid). The spread, in this case 1.00 goes to the market maker. Similarly, if you intend to buy and someone else intends to sell, you typically pay the Ask and the seller gets the Bid. If however, you're placing a limit buy order (i.e. a limit on how much you're at maximum willing to pay) at let's say 99.80, and the seller places a regular market order at best price, the trade is executed at 99.80, which saves you 0.7.
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