Learn the difference between Ask and Bid Prices And Spreads in this article and what happens when volumes get thin in stock markets.
This month stock markets are witnessing low volumes in trading. Stock Prices are decided on the current demand and supply, and not what has happened in the past.
Let us take an example. Let say XYZ stock is trading at 515 and the first quarter results have come in beating market expectations. It is obvious that traders and investors will be willing to buy the stock and trading on that stock will get very active.
Due to good results, both the buyers and seller will become very active in this stock. If you see your trading platform you will see that it will show Ask and Bid prices.
What is ‘Bid’ in stock trading
Bid the best price a buyer, trader or a dealer is willing to buy that stock or an option at that particular time. Best price is the highest price buyer is bidding or willing to buy the stock.
What is ‘Ask’ in stock trading
Ask is the price a seller of a stock or an option is willing to accept to sell that stock or option. Best Ask is lowest price a seller is willing to sell stock at that particular time of trading.
Whenever they both match a trade is completed and then if trading volumes are high the Bid and the Ask prices both go up. This will take the stock price up. However if the demand of the stock is low due to whatever reasons, both the Ask and the Bid prices may go down taking the price of stock down.
For example if XYZ stock’s first quarter results would have come poor, the Ask and Bid prices both would have gone down as interest in trading that stock would have gone down.
Job of Market Makers
Sometimes when there is very low demand and supply market makers come into action and displays their prices. When the volumes are very thin the software does not understand and you may see huge differences between Ask and Bid prices. Like Ask at 515 and Bid at 500. Due to this huge difference trading may not take place at all.
Here is where the market makers come into action and controls the Ask and Bid prices so that trading does takes place.
Right now trading volumes are low and it is the job of market makers to check that Ask and Bid prices do not have too much of gap. These are mostly done in stock and derivatives where still they find reasonable traders trying to do trading, but due to huge difference between Ask and Bid the trade is not happening.
If they do not control trading prices, retail traders may get confused and those hitting market orders may get stocks at amazing high prices and suffer losses.
If traders keep getting confused they will stop trading and stock markets will remain stabilized not moving for years. This the market movers do not want, hence they control the Ask and Bid prices.
If investors lose interest in stock markets, no new company will come up with an IPO (Initial Public Offer). It is already happening in India since last 2 years. Very few companies have come with an IPO. It is due to IPOs new companies can collect money from the stock market to expand their business. Please note that a company does not have to give back the money to an investor who buys its stock, except when it decides to buy back a few shares. This happens rarely. A company only give dividends to its stock investors.
Dividends also comes from the profits made from the business, not money paid to investors from their pockets.
If investors do not invest in IPOs or in stock markets, a country’s economy may get hit. This the governments do not want. This is the reason when thin volumes are seen in stock exchanges governments gets worried. They either come up with statements or actions to bring back investors beck to the stock markets.
What is A Spread?
The difference of the price between Ask and Bid is the Spread. When the Spread is tight, volumes are good. However when the Spread is wide, it is for certain that Volumes are low.
Right now volumes are thin, so the Spreads in many stocks, options and futures must be wide.
It is advised that during low volumes traders should trade with caution. Even if they want to trade they must not hit market orders but try to hit limit orders only where they can decide at what price they want to buy or sell a stock.
If you have any questions please ask in the comments section.
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