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Liquidity Riskbeginner

Bid-Ask Spread

The bid-ask spread is the gap between the best price a buyer will pay (the bid) and the best price a seller will accept (the ask or offer). It is the most direct measure of liquidity tightness: the cost of an immediate round trip, buying then selling at once. The quoted spread is simply Pask−PbidP_{\text{ask}} - P_{\text{bid}}. To compare stocks of different price levels, it is scaled by the mid-price to give a relative (proportional) spread in percent. A narrow spread signals a liquid, competitive market; a wide spread signals illiquidity and rewards the market maker for the risk of holding inventory and trading against better-informed counterparties.

Try it yourself

Stock liquidity — measuring tightness, depth and price impact

Is this stock liquid? Read the spread and the Amihud ratio.

A tight spread is cheap to round-trip and a low Amihud ratio means a dollar of trading barely moves the price. Both point to a liquid name. The Amihud ratio is the one to watch: higher Amihud = more price impact per dollar = LESS liquid.

Quoted spread %
0.08%
= US$0.04 / mid US$50.00
Amihud ILLIQ (×10⁶)
1.60e-5Liquid
raw 1.60e-11 per US$ traded
Spread costs and turnover (% of mid-price / float)
Quoted spread0.08%Effective spread0.04%Turnover0.50%
Mid-price Pₘᵢ𝒹 = (ask + bid)/2US$50.00
Quoted spread Pₐₛₖ − P_bidUS$0.04 (0.08%)
Effective spread 2·|Pₑₓₑ𝒸 − Pₘᵢ𝒹|US$0.02 (0.04%)
Turnover Volume / Shares out.0.50% / day
Daily dollar volume P · VolumeUS$500100000
Amihud ILLIQ |Rₜ| / (P·Volume)1.60e-11 (×10⁶ = 1.60e-5)
A tight spread of 0.08% and a low Amihud ratio mark this as a liquid name: a dollar of trading barely nudges the price.
Spread % 0.08%Turnover 0.50%Amihud verdict Liquid
Try this. Load the small-cap, then drag daily volume up toward the blue-chip level. Watch the Amihud ratio collapse: same price move, far more dollars traded, so each dollar moves the price less. Then drop the daily |return| and notice the spread is unaffected — spread (tightness) and Amihud (price impact) are separate dimensions of liquidity.
Reflect: two stocks share the same quoted spread. Which measure would still tell you they differ in how much a large order moves the price?

Why it matters

The spread is the toll you pay the market maker for instant service. They quote a price to buy from you (lower) and a price to sell to you (higher), and the difference is their compensation for standing ready, carrying inventory, and the danger that whoever they trade with knows something they do not. In a busy, competitive stock many dealers compete and the toll is tiny, a cent or two. In a thin or risky name the toll widens. Crucially, half the spread is the cost you pay every single time you demand immediacy.

Formulas

Quoted (absolute) spread
Quoted Spread  =  Pask−Pbid\text{Quoted Spread} \;=\; P_{\text{ask}} - P_{\text{bid}}
The raw distance between the best offer and best bid, in price units. It is the cost of an instant round trip for one share.
Relative (proportional) spread
Relative Spread  =  Pask−PbidPmid,Pmid=Pask+Pbid2\text{Relative Spread} \;=\; \dfrac{P_{\text{ask}} - P_{\text{bid}}}{P_{\text{mid}}}, \qquad P_{\text{mid}} = \dfrac{P_{\text{ask}} + P_{\text{bid}}}{2}
Scaling by the mid-price expresses the spread as a fraction (often in percent or basis points), making it comparable across stocks with different price levels.

Worked examples

Scenario

Stock X is quoted bid 49.95 / ask 50.05. Stock Y is quoted bid 20.00 / ask 20.40. Which is more liquid in proportional terms?

Solution

Quoted spreads: X is 50.05 − 49.95 = 0.10; Y is 20.40 − 20.00 = 0.40. Mid-prices: X is 50.00, Y is 20.20. Relative spreads: X = 0.10 / 50.00 = 0.20%; Y = 0.40 / 20.20 ≈ 1.98%. Stock X is far tighter and therefore more liquid: a round trip costs about a fifth of a percent versus nearly two percent for Y. Comparing the raw 0.10 against 0.40 already favours X, but scaling by price confirms the gap is even larger in proportional terms.

Common mistakes

  • ✗The spread is just a broker fee. The spread is the market maker’s compensation for providing immediacy, carrying inventory, and bearing adverse-selection risk; it is separate from any explicit brokerage commission.
  • ✗You can buy and sell at the same price. You buy at the (higher) ask and sell at the (lower) bid, so a round trip loses the full spread even if the price never moves.
  • ✗Absolute spreads are comparable across stocks. A 10-cent spread on a 20-dollar stock is far costlier in percentage terms than a 10-cent spread on a 200-dollar stock, so spreads are scaled by the mid-price.
  • ✗A wide spread is purely a dealer ripoff. Spreads widen with genuine costs: thin volume, volatile prices, and the risk of trading against informed investors, so a wide spread reflects real liquidity conditions.

Revision bullets

  • •Spread = ask minus bid, the cost of an instant round trip
  • •Quoted spread = Pask−PbidP_{\text{ask}} - P_{\text{bid}}
  • •Relative spread scales by the mid-price for comparability
  • •Narrow spread = liquid; wide spread = illiquid
  • •Compensates the dealer for inventory and adverse-selection risk

Quick check

A stock is quoted bid 99.90 / ask 100.10. Its quoted spread and relative spread (to the mid) are approximately

Why must the bid-ask spread be scaled by the mid-price when comparing two stocks?

Connected topics

Stock LiquidityMarket DepthEffective SpreadAmihud ILLIQ

Sources

  1. Amihud & Mendelson (1986)
    Amihud, Y., & Mendelson, H. "Asset Pricing and the Bid-Ask Spread." Journal of Financial Economics, 17(2), 223–249, 1986.
    Shows the bid-ask spread is a priced liquidity cost that raises required returns.
  2. Jorion, FRM Handbook (2011)
    Jorion, P. Financial Risk Manager Handbook. 6th ed. GARP / Wiley, 2011.
    Presents the bid-ask spread as the core measure of market liquidity tightness.
How to cite this page
Dr. Phil's Quant Lab. (2026). Bid-Ask Spread. Derivatives Atlas. https://phucnguyenvan.com/concept/frm-bid-ask-spread
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