Steemit Crypto Academy [Beginners' Level] | Season 4 Week 1 homework: The bid-ask spread for @awesononso by @alexanderpeace

Greetings. This is my homework post for the beginners level: Season 4 week 1 for professor @awesononso. Thank you professor for the class. It was eye opening.

Image design on Canva by me

QUESTION 1

Properly explain the Bid-Ask Spread.

Before I proceed to explain Bid -ask spread, we need to know what bid and ask is.

In our regular daily living and also in the crypto world, we engage in buying and selling. When I go to the regular market to buy a commodity, there's an amount I don't want to buy the good higher than and there's an amount the seller doesn't want to sell his good lower than. This situation brings us to what we know as bid price and ask price. Let's see what bid price and ask price is.

Bid price

The bid price is the highest price or maximum amount a buyer of an asset or commodity is willing to pay for that particular asset or commodity at a particular time. For example I want to buy a school bag for 20 steem. I don't intend to pay higher than 20 steem for the bag hence 20 steem is the bid price for that commodity.

Ask price

The ask price is the lowest price or minimum amount a seller is willing to sell a commodity or an asset at a particular time. The person I want to buy the school bag from wants to sell it for a minimum of 25 steem. The 25 steem is the ask price.

You'll notice that there's a difference in the price am willing to buy and the price the seller is willing to sell. This difference in the bid price and ask price is called Bid-ask spread. Before we quickly x-ray the bid-ask spread, note that the bid points to the demand of the asset while the ask points to the supply. Let's proceed.

The bid-ask spread

The bid-ask spread is the difference between the bid price and the ask price of an asset.
Expressing this in mathematical format we'll have:
Bid-ask spread = Ask price - Bid price.
We'll see practical calculations of the bid-ask spread in question 3.

The bid ask spread is a recurrent phenomenon in the crypto market. It's the amount with which the ask price is higher than the bid price.

In the market, we have market makers who place limit orders. A limit order is an order to buy or sell an asset or commodity at a given price or more.
A sell limit order can be carried out at the limit price or higher price while a buy limit order can be carried out at the limit price or a lower price. Through the limit orders the Market makers determine the price they want to buy or sell an asset. This means that a market maker sets the bid price if he want to buy an asset and the ask price if he wants to sell an asset through the limit order.
Below is a screenshot of a bid ask spread.

Source

From the screenshot above, the green wave is the bid side while the red wave is the ask side. The gap between them is the bid-ask spread otherwise called the spread.

QUESTION 2

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

The bid-ask spread is important in the market because it's used to determine the liquidity of the market. By market liquidity, am referring to the extent to which an asset can be readily sold or bought.
A market is said to be liquid if there are many buyers and sellers and trades are easily carried out.
We know that demand and supply are always at play in the market. When more people are willing to buy an asset at a given price and a particular time, we say that there's demand while there's supply when a particular asset is readily available in the market.
The market becomes liquid when there's a balance between supply and demand which enables trades to be easily carried out.
This state is obtainable if there's minimal difference between the ask price and the bid price. This means that for a market to be liquid, the bid ask spread has to be small hence will result to high trading volume. If the bid-ask spread is much, it will cause the Market to be illiquid hence resulting to low trade volume. In simple terms the smaller the bid-ask spread, the more liquid the Market will be and vice-versa.

Source
From the screenshot above , we see that the bid-ask spread is small indicating more limit orders from buyers and sellers, this leads to more trading volume hence the market is liquid while in this second screenshot below,

Source

the bid-ask spread is wider. This shows that the limit orders from buyer sand sellers are not much, leading to low trading volume hence the market is illiquid.

QUESTION 3

If Crypto X has a bid price of $5 and an ask price of $5.20.
a.) Calculate the Bid-Ask spread.

The bid price = $5
The ask price = $5.20
Bid-ask spread = Ask price - bid price
= $5.20 - $5
= 0.20
Therefore bid-ask spread = $0.20

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

%spread = (spread/Ask price) x 100
= (0.20/5.20) x 100
= 0.03846 x 100
= 3.846%
Therefore%spread = 3.846%

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.

The bid price = $8.40
The ask price = $8.80
Bid-ask spread = Ask price - bid price
= $8.80 - $8.40
= 0.40
Therefore bid-ask spread = $0.40

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

%spread = (spread/Ask price) x 100
= (0.40/8.80) x 100
= 0.04545 x 100
= 4.545
Therefore %spread = 4.545%

QUESTION 5

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

Crypto X has higher liquidity than crypto Y because it has a smaller spread than Crypto Y.

QUESTION 6

Explain Slippage.

Source

Slippage is the change in price of a market order that happens between the time the order was placed and when it was executed. Cryptocurrencies we know are very volatile and changes in price easily hence slippages are easily encountered in crypto trades. If for example I placed an order to buy an asset at 100 steem and during the window between my order placement and it's execution, there happened to be a change in price and my order was executed at 100.70 steem, this change in price is known as slippage.
The difference between the price I filled for my trade and the price it was executed is called slippage.

QUESTION 7

Explain Positive Slippage and Negative slippage with price illustrations for each.

Positive slippage

Positive slippage is the slippage that occurs when there's a favourable alteration in the price of an order execution from the filling order.
For a buy order, when an order is executed at a price lower than it was filled, a positive slippage has occurred.
For a sell order, when an order is executed at a price higher than it was filled, a positive slippage has occurred.
If I filled an order to buy steem at $50 and it was executed at $49 instead, that's a positive slippage which would be;
$50 - $49 = $1 and if I wanted to sell my steem at $50 and it was sold at $52, that's a positive slippage which would be $52 - $50 = $2.

Negative slippage

Negative slippage occurs when there's an unfavorable alteration in the price of an order execution from the filling order.
In a buy order, when an order is executed at a price higher than filled, a negative slippage occurs.
In a sell order, when an order is executed at a price lower than filled, a negative slippage occurs.
If I filled an order to buy steem at $60 and it was bought at $60.05, a negative slippage has occurred and it would be $60.20 - $60 = $0.20.
If I filled an order to sell steem at $70 and it was sold at $69.80, a negative slippage has occurred and it would be $70 - $69.80 = $0.20.

CONCLUSION
Bid-ask spread is useful in buying and selling. It helps the trader to know the liquidity of the market and could help in trading decisions. Understanding spread and spillages can aid the trader avoid loses and make gain in trading. Thank you professor for the knowledge impacted.