Bid-Ask Spread
Reflects market liquidity
A narrow spread indicates high liquidity, while a wide spread suggests lower liquidity or higher volatility.
Liquidity is often measured as the bid-ask spread divided by the ask price. High liquidity typically corresponds to a spread of less than 0.1%.
Negative bid-ask spread
This happens when seller is selling at a price lower (ask price) than the price the seller is willing to purchase (bid).
If a negative spread exists, traders can buy at the lower ask price and sell at the higher bid price, creating a risk-free arbitrage opportunity. This activity quickly corrects the spread back to positive in efficient markets.
Bid Price
- The price at which buyers are willing to purchase an asset
- Sellers receive this price when they sell the asset
Ask Price
- The price at which sellers are willing to sell an asset
- Buyers pay this price when they purchase the asset
Split Spread Order
- Placing split spread orders involves submitting orders that are priced within the bid-ask spread of a security
Typically add liquidity to the market
In some cases, exchanges may provide rebates for adding liquidity.
For example, if the bid is 11, a split spread order placed at $10.50 creates a new price level for potential trades, enhancing market depth and liquidity.
Split spread orders are particularly useful in markets with wide bid-ask spreads, such as ETFs or less liquid securities. These orders can help reduce trading costs and improve execution efficiency. ETFs often have wider bid-ask spreads because they consist of baskets of underlying securities.