July 28, 2014

Bid-Offer spread explained

The bid-offer spread is something that should always be considered as an investor as it can eat away at your returns. It simply refers to the buy and sell price of a particular security at a specific time.

The bid refers to how much you can sell your security for and the offer price is the lowest point that you can buy at. The difference between these two values is known as the bid-offer spread, and it always costs more to buy than sell. This difference allows market makers to make money on their services.

So let’s look at a practical example, imagine we are purchasing an Exchange Traded Fund, it features a bid price of 120p and an offer price of 140p. Therefore the bid-offer spread is 20p. Therefore you are already at a 20p deficit on each unit purchased, ignoring other costs such as commission’s.

The tighter the spread is, the better it is for you. However, the tightness of the spread usually depends on the type of asset. Those assets with high liquidity such as currency will usually have the smallest bid-offer spread. But those assets which are less in demand and less liquid will have a wider spread.