Before getting into details about bid and ask prices, it’s essential to know the basic principles on which the financial markets rely. Investments represent the safest and most widely spread way to increase our net worth by constantly placing a small portion of salary or savings into valuable assets, such as stocks, commodities, cryptocurrencies, or real estate.
Investing in assets and businesses that are listed on the stock market has been the way for many non-famous people to secure a decent living for the rest of their lives – yet a lot of people who are new to this concept are afraid of doing it and feel overwhelmed by how much information they need to process before investing: How do I buy? Where from? Is there someone selling these assets to me, or am I buying them directly from the platform? Why do some assets have better liquidity than others? And much more.
About the rules surrounding Financial Markets
First, there are traders who ensure market liquidity, also known as market makers, whether we’re talking about institutions or retail investors with large amounts of cryptocurrency. The market could not function correctly without those entities willing to trade their assets. The entire global economy works on the principle that people offer money against things (consumer objects, services, or assets) they need or want for various reasons. Everything revolves around supply and demand. Financial markets do not make abstractions from these essential rules.
A little about Market Makers and Takers
As stated above, market liquidity is the most critical characteristic of a functioning market. Liquidity refers to buying and selling assets quickly at prices consistent with their actual value. This liquidity is built by what we call market makers and market takers – or market creators and participants. They operate oppositely: some continuously sell, and some buy to provide to the market. Therefore, market makers are asset holders who issue buy or sell orders, like retail traders, trading companies (such as JP Morgan and Goldman Sachs), or even listed companies that can offer assets from their own portfolios.
The spread between Bid and Ask prices
The spread refers to the price difference when the amount asked is more significant than the price buyers are willing to offer for the same asset. More specifically, the spread refers to the price gap that differentiates the maximum price someone in the market is willing to pay for a particular asset and the lowest price the market maker is willing to accept.
Market makers (the ones that place orders in the Orderbook) offer their assets at a specific price that they desire, called the asking price – while on the other side of the market, the ones that want to buy assets at their preferred price are creating buy orders in the Orderbook – called bid prices. The difference between the two is called “spread” or transaction cost and is collected by market makers.
The spread is primarily how we calculate the market’s supply and demand for a particular asset because when the difference between the bid and ask price gets too significant, changes in supply and demand tend to occur.
How to calculate the Spread?
The difference between the bid and ask price is divided by the actual selling price to calculate the remaining spread percentage. The trade volume of entities willing to buy and sell at specific prices determines the spread. The spread percentage becomes higher when the volumes are lower, and there are not as many people interested in that asset. Spreads also widen during high or volatile fluctuations, so the percentage will be higher. Also, differences between bid and ask prices can be significant, especially when margin trading.
It is recommended to use limit orders instead of market orders when trading because these allow us to choose exactly the price we desire to acquire assets. At the same time, limited prices may not represent the quickest way to purchase assets, but we don’t expose ourselves to high fluctuations when trading.
What is the slippage?
Slippage, unlike the spread, represents the difference between the price we expect the trade to get settled and the price level at which it actually executes. The slippage occurs mainly in market orders and it is one of the reasons why limit orders were recommended above, because of the situations that can quickly change the price during periods of high volatility.
Anyone can be an investor. On a global scale, crypto remains a relatively young asset class with an investor base that’s still growing. At IXFI, we’re building a community where everyone is welcome. We mean it when we say that anyone can be an investor. Try it for yourself; join Your Friendly Crypto Exchange today and see where you fit in.
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