Do you ever wonder exactly whats going on in the trading pits after youve sent an order to purchase stock? Youve no doubt seen market quotes either online or even in the newspaper. Have you noticed that there are always two sets of prices given? What exactly do those mean and where will my order get filled? Lets discuss the basics of the two prices you see.
Lets say youre trading stocks. The first price (usually the one on the left) is called a bid. This is the price at which the market is offering to buy the stock. If you sell your stock at the market, this is the price that youll get. The second price (usually located on the right) is called the ask. This is the price at which the market will sell you the stock. If you submit an open order to buy shares at the market, you will get them for the ask price. Another element that comes into play sometimes is the size of the bid and ask. Usually, theres an order size that comes with the bid and ask. If that size is exceeded then the price will usually change and generally, that small price change will move slightly against you since you’re creating a demand for that stock.
The difference between the bid price and the ask price is called the spread. If you look at the spread of a large cap stock that trades over a million shares a day, and compare that to a small cap stock that only trades a thousand shares a day, youll see a huge difference. Stocks that are more liquid (or more activity) will have much smaller spreads than those with less activity. Thus, you will get a better fill (or deal) for a market order on a more liquid stock. One tool you can use to possibly improve your price is to use limit orders. If you want to buy XYZ at no more than $12 and the bid is $11.50 and the ask is $12.50, you can place a purchase order with a limit of $12. This means that the order wont be filled unless you can get it for $12 or better.
One word of caution with limit orders is that the market could run away without you if used with a buy order. And if your order is filled, youll be buying the stock on a downtick, which means it could be making a major move down. As a general rule, its not a good idea to use limit orders when selling stocks as the market could make a big move against you without ever hitting your limit price and youd be stuck with a big loss.