Brief Summary: The offer price is the highest price that a buyer will pay to purchase an asset, or the lowest a seller will accept on an asset. Offering an asset is the act of making traders aware that it is available for sale.
Full Overview: As a trader, the price at which you trade depends on whether you’re buying or selling in the market. Understanding the differences between the bid and the offer price and how they’re affected by current market conditions is crucial for a trader.
The bid/offer spread doesn’t only impact your trading performance but also trading costs. Widening spreads can lead to significant upside and downside gaps, which may hit your stop-loss levels or cause an even larger loss than anticipated.
In this article, we’ll focus on the offer price – The lowest price at which market participants are willing to sell a financial instrument.
Bid/Offer Prices Explained
Bid and ask prices, also known as bid and offer prices, are prices of a two-way quotation system that represent the prices at which a particular security can be sold and bought on the market. The bid price is the price that buyers are willing to pay for a financial instrument, while the ask or offer price is the price at which sellers are willing to sell the same instrument to potential buyers.
In other words, if you’re selling a security on the market, you’ll receive the bid price, and if you’re buying a security on the market, you’ll have to pay the ask (offer) price. A transaction or trade occurs whenever the bid and offer price meet, i.e. a buyer and a seller agree to strike a deal at the same price.
Why Do Bid and Offer Prices Differ?
The main reason why bid and offer prices are not the same is that buyers try to buy an instrument at a price as low as possible, while sellers aim to sell them the instrument at a price as high as possible. When markets are illiquid, the difference between the bid and offer price tends to be quite high.
The reason for this lies in the total number of buyers and sellers active in the market: An illiquid market has a smaller number of market participants compared to a highly liquid market. Examples of illiquid markets include small-cap stocks with a small daily trading volume or exotic currency pairs such as EUR/RUB (euro vs Russian ruble) or GBP/INR (British pound vs Indian rupee).
When both the bid and offer price meet, i.e. buyers are willing to pay the price offered by sellers, a transaction occurs and a trade gets executed.
What Impacts the Offer Price?
As noted earlier, the offer (or ask) price is the price at which sellers (or market makers) are willing to sell a financial instrument. Many factors can influence the current offer price in a market, including the overall trend in the market, opening gaps, availability of sellers and market liquidity, and trading hours, to name a few.
When markets are trading in strong uptrends, sellers tend to increase their offer price to account for the higher demand. On the other hand, since buyers are willing to pay the higher offer price to join the trend, overall prices increase and the market keeps trading higher. Similarly, when markets are trading in a strong downtrend, buyers are not willing to pay a high price for the underlying instrument which pushes sellers to lower their offer price. These circumstances keep pushing the overall price and trend to the downside.
Gaps occur when the opening price differs from the previous closing price in a market. Gaps are quite common in illiquid markets with a small number of buyers and sellers or when important news hit the market over the weekend.
This is what happens: In upside gaps (when the opening price opens higher than the previous closing price), sellers weren’t willing to sell at a lower price and buyers who wanted to make a transaction had to accept the higher offer price. This is usually the result of news that is bullish for a financial instrument.
In downside gaps (when the opening price opens below the previous closing price), buyers weren’t willing to accept the current offer price and instead push the bid price lower. Sellers who want to strike a deal have to accept a lower selling price.
Liquidity has a major influence on the bid/offer spread. When liquidity is low, spreads tend to widen which means that bid prices are pushed lower and offer prices higher. The opposite is true when liquidity is high: Spreads get narrower, bid prices are pushed higher and offer prices lower.
This happens because market participants who want to make a transaction in a highly-liquid market have to compete with other buyers and sellers which makes the bid and offer prices more competitive. Sellers have to lower the offer price, while buyers have to increase their bid price to make a deal.
Open market hours
Last but not least, open market hours play a crucial role in the difference between bid and offer prices. In the first few minutes after a market opens, liquidity tends to be lower which leads to wider bid-ask spreads. As liquidity picks up, spreads start to narrow again.
This is especially important for day traders who shouldn’t open or close their trades in the first few minutes after the opening or before the closing of a market to avoid higher trading costs.
The difference between the bid and the offer price is called the spread. That’s the cost you incur for a round-trip in trading, i.e. when selling a long position or when covering a short position. The spread of a financial instrument is an important indicator for traders as highly-liquid markets tend to have a very tight spread, while illiquid markets can have significantly wide spreads.
Spreads can also widen during periods of high market volatility, such as immediately after the release of important market reports or breaking news. Traders who are not willing to trade news should stay at the sidelines during those times until the dust settles and spreads get narrower again.
When trading, you need to take into account the spread of the instrument you’re trading since it can have a substantial impact on your trading performance.
In the stock market, large and very liquid blue-chip companies like Apple can have a spread of only a few cents, while smaller stocks with a very low daily trading volume may have a spread that is multiple times
In most cases, the spread of a financial instrument represents the profit of a market maker. A market maker who is buying a stock at $100 and selling the same stock at $100.50 would keep the difference between the two prices as a profit.
It’s critically important to understand the difference between bid and offer prices in a market. The bid price is the highest price buyers are willing to pay for a financial instrument, while the offer price is the lowest price sellers are willing to accept for a financial instrument. When bid and offer prices meet, a transaction occurs and a trade gets executed, pushing the market to a new equilibrium price.
Bid and offer prices are affected by many factors, including the trend of a market, liquidity, and open market hours. Large differences between bid and offer prices often lead to gaps as well, especially when breaking or unexpected news hits the market when it’s closed. Make sure you clearly understand the difference between bid and offer prices before placing your next trade.