Crypto Academy / Season 4 / Week 1 - Homework Post for @awesononso

Introduction

In dealing with cryptocurrencies or other kinds of exchanges, there are some concepts and terminologies that one needs to get familiar with. Thus exchange, whether foreign or exchange has some unique language.

One of such is the concept of Bid-Ask Spread.
Very true is the fact that, if one is not very familiar with these terms, meaning and application, such a person might be unable to navigate his or her way effectively around the shores of cryptocurrencies or exchanges as a whole.

As it is, this concept affects some key events in the market. It can determine how profitable a trader is. With proper grasp of this concept, investors will be better positioned to take advantage of the prevailing market situation. Thus, I am going to x-ray some key points about this concept by attempting the questions below.

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Question 1: Properly explain the Bid-Ask Spread.

The bid-ask spread refers to the difference or margin between the highest price at which buyers are willing to buy ( bid price) and the lowest price at which sellers are willing to sell ( ask price).

Buyers always attempt to purchase the best value of a commodity at the lowest price possible. Thus, they keep a benchmark beyond which they are not willing to go. Since going beyond that might imply paying too much for the commodity.

Sellers on the other hand intend to sell their goods at the highest possible price. Accordingly, they will keep a threshold below which the price must not fall. As selling below that price implies they are giving away the commodity at a very cheap price.

Thus, the gap between the benchmark price kept by buyers above which they will not make purchase for fear of overpricing and the threshold price below which sellers are unwilling to accept for their good, commodity or asset so as not to undervalue and underprice is what is referred to as the bid-ask spread.

Simply put, bit-ask spread represents how much the ask price exceeds the bid price for a particular asset. That is, what the buyer is willing to pay against what the seller is willing to receive so that an exchange can occur.

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Question 2: Why is the Bid-Ask Spread important in a market?

Bid-Ask spread is very important in a market. It can affect and Influence a lot of factors and outcomes in the market. The bid-ask spread can be used to determine a whole lot of things in the market. Some outstanding importance of Bid-Ask spread include:

• It determines how quickly an asset or security in the market is bought of or sold out.
• The bid-ask spread influence the market size and population. It contributes to how large the volume of trade in a particular asset is.
• It can serve as an attracting or repelling force for investors and traders as favourable (small) bid-ask spread invites more people to take part in the market while larger and wider bid-ask spread scares people from coming in to trade an asset.
• It used to calculate how strong are the demand or supply forces in the market for a security or asset.
• The bid-ask spread represents the transaction cost.
• It is a measure of the liquidity of an asset.

Question 3: If Crypto X has a bid price of $5 and an ask price of $5.20,

a.) Calculate the Bid-Ask spread.
b.) Calculate the Bid-Ask spread in percentage.

Solution

• A. The formula for calculating Bid-Ask Spread is :
  Spread = Ask Price - Bid Price
  Therefore: Ask Price = $5.20 , Bid Price = $5
  = $5.20 - $5 = $0.20
  So Bid-Ask Spread for Crypto X = $0.20

• B. Bid-Ask Spread in percentage is calculated using the formula:
  %Spread = (Spread/Ask Price) x 100
  Therefore %Spread for Crypto X
  = (0.20/5.20) × 100
  = 0.0385 (3 s.f) × 100
  = 3.85%

Question 4: If Crypto Y has a bid price of $8.40 and an ask price of $8.80,

a.) Calculate the Bid-Ask spread.
b.) Calculate the Bid-Ask spread in percentage.

Solution

• a. The formula for calculating Bid-Ask Spread is :
  Spread = Ask Price - Bid Price
  Therefore: Ask Price = $8.80 , Bid Price = $8.40
  = $8.80 - $8.40 = $0.40
  So Bid-Ask Spread for Crypto Y = $0.40

• b. Bid-Ask Spread in percentage is calculated using the formula:
  %Spread = (Spread/Ask Price) x 100
  Therefore %Spread for Crypto Y
  = (0.40/8.80) × 100
  = 0.0455 (3 s.f) × 100
  = 4.55%

Question 5: In one statement, which of the assets above has the higher liquidity and why?

Crypto X has the higher liquidity because it boast of a smaller bid-ask spread.

Question 6: Explain Slippage.

Slippage describes an occurrence whereby an asset is bought or sold at a price different from the price at which the order was placed. It refers to a situation where trade or exchange is undertaken at a price other than the price that was quoted as at the time of placing the trade. It is the difference between expected price and executed price of a trade.

This is very common among assets that are prone to swift changes in price such as cryptocurrencies. That is, such assets might have their prices change over very short time interval such that between the time that a trade was ordered to when it was actually executed, the prices differ.

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This condition of swift changes in price called volatility is one factor what causes this slippage to occur. Another factor is when there is a wide spread. Also, when an order, like a large order is not able to be satisfied immediately probably due to unavailability of asset at the time or low volume and before such asset becomes available, the price must have changed.

Whenever there is a change in the bid-ask spread between the time a request was made and the time the request was executed, a slippage occurs. When trading orders are not matched immediately enough, there is increased chances of slippage occuring.

Generally, slippage the term given to a situation whereby a trade order is made at a particular price, but the trade is actually performed at another price. That is, when an order or request is filled or completed at a price different from the intended price at the point and time of request.

Question 7: Explain Positive Slippage and Negative Slippage with Price Illustrations for Each.

Slippage ordinarily does not imply more loss or profit. It can have both beneficial outcome or negative outcome depending on direction of the slippage and the type of order.

• Positive Slippage: This is a condition whereby the slippage brings about greater gain to the investor or trader. It is when the slippage results in more favourable trade and profit. That is, if it is a sale trade and the bid price becomes higher than the intended price. Or if it is a buy trade and the ask price becomes lower.

For instance, if I requested to buy BTCUSD at a price of 1.6372 but the order got completed at 1.6350, This implies that I have bought the pair at 22 pips lower price meaning it was cheaper for me.

Also, if I offered to sell LTCUSD at 1.3456 but the order went through at 1.3470. This means I have sold the asset at a price 14 pips higher meaning that I have sold it even more expensive than I intended.

These instances demonstrate what a positive slippage is.

• Negative Slippage: This type of slippage occurs when a trader or investors incurs more damages or some from a trade as a result of a shift in the bid-ask spread, volatility or unmatched order. Negative slippage gets the tag because the result of such trading adventure is usually a reduction in potential profit.

Here, the trader is made to pay more for an asset if it was a buy trade or sell at a lower price if it was a sell trade. That is, a buyer is made to increase his bid price and accept a seller's raised ask price. While a seller is forced to reduce the ask price and accept the lower bid price of the buyer.

For instance, if a buyer initiated a trade for XRPUSD at 1.7639 but the order got executed at 1.7643. Here, the buyer has been made to pay an extra 4 pips for the asset. Meaning that it became more expensive.

Also, if a seller placed an order for ETHUSD at 1.4487 but the trade got through at 1.4461. The seller has sold the asset for 26 pips less. This implies that the asset was sold at a lower value than intended.

These illustrate negative slippage.

Conclusion

For anyone who has had some trading experience, it can be agreed that without getting a proper grip of what goes on in the market and what indices to look out for, one might end up inviting some terrible and horrible losses. There are tools and strategies to be employed in the market, all these are being backed up by fundamental concepts.

Accordingly, it is pertinent that traders and investors get themselves acquainted with these concepts. One of such critical analytic concept is that bid-ask spread. Obviously, this can bring about major shifts in the market as it affects and influences a lot of market forces.

Consequently, with Bid-Ask spread being a fundamental concept in cryptocurrency trading and foreign exchange, it is necessary that investors be more mindful and conscious of it while making investment decisions. Knowing how to calculate it properly as well as knowing the potential of slippage and spread has, can be vital in securing investors capital while guaranteeing their profits.

Therefore, traders should carefully calculate the spread of currency pairs and as well be mindful of the possible incidence of slippage so they can make the most out of the market.

This knowledge by Prof @awesononso is quite commendable. Thank you