Crypto Academy /Season 4 / Week 1 - Homework Post for Professor @awesononso || Bid- Ask Spread
Hello steemains
Glad to be back to season 4 of Crypto Academy, glad to have you back prof @awesononso, as always nice and informative lecture this week, below is my homework task.
1. Properly explain the Bid-Ask Spread.
The word Bid-Ask is a bisyllabic word formed from "Bid and Ask". As such it is pertinent to know what Bid and Ask means first.
Bid
Bid is the highest price of an asset or cryptocurrency which a buyer is willing to pay for that assest at a particular time. Every buyer usualy wants to purchase an asset at a price favourable for him( that is lowest price he can get it). The bid price simply represents the level of demand for a particular asset or cryptocurrency at a particular time. The bid price is usually denoted with a green colour(as seen on the screenshot below).
Ask
Ask refers to the least price of an asset or cryptocurrency at which the owner wants to sell the asset at that point in time. The Ask is simply the supply of a particular asset at a point of time(colored red on the screenshot below)
After looking at the meaning of the two words "Bid and Ask", therefore Bid-Ask spread is the difference between the Bid price and Ask price of an asset or cryptocurrency. It is seen as the difference between the highest price a buyer is willing to pay for an asset and the least price a seller is willing to sell an asset or commodity at a specific point in time.
From the screenshot above, the difference that lies in-between bid price and ask price is what, is referred to as the Bid-Ask spread or Spread. In a nutshell, Bid-Ask spread is known as de facto measure of a market liquidity.
Bid-Ask spread can be mathematically expressed as;
Bid-Ask Spread = Ask price - Bid price
The Bid-Ask spread is the transaction cost of an asset or cryptocurrency. In cryptocurrency trading, price traders buys an asset at the ask price and sells at the bid price, while market maker buys an asset at the bid price and sells at the ask price. The mid point of the spread is denoted as fair value. Fair value can be referred to as the best price of an asset favourable to both the buyer and the seller.
2. Why is the Bid-Ask Spread important in a market?
The Bid-Ask spread is very important in trade market in various ways and serves as an indicator to some major criteria in trading.
•Bid-Ask spread is an important indicator of the liquidity of an asset in the market. The more liquid the asset is in the market, the more actively it changes hands and the better the price of the asset at that point in time.
•Bid-ask spreads reflects the future risk of a market maker offering a trade, as the width of the spread is not solely dependent on the liquidity of an asset but also on how much the price value of an asset or commodity can change rapidly.
• Bid ask spread is also a measure of the trading risk of the stock in the market. For instance, the purpose of executing a buy or place order in the market is to get the stock as close to the best price as possible. The higher the bid-ask spread, the higher the risk in trading the stock and this implies an indirect cost on trading.
• Bid ask spread serves as a guide on the type of order to be placed in the market. If the spread is wide this indicates that the spread value is big and there are no much willing buyers or sellers of that commodity hence trading of that commodity will take much longer time, at this time a limit order will be the best choice for a trader to take. And if the spread is close or narrow, it indicates that the spread value is very small or minuite, which is to say liquidity level is low and this will favour a trader that wants to buy or sell a commodity within a short frame of time. In a nutshell, the spread helps traders in determining the market liquidity of a commodity or cryptocurrency.
• The bid-ask spread indicates of the direction of the market movement, the studying of the narrowing and widening of the bid-ask spread will help traders make best decisions before trading, which in turn helps them gain more profit.
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) using the formula;
Bid-Ask spread =Ask price - Bid price
Note: Bid Price = $5
Ask Price = $5.20
Therefore, Bid-Ask Spread = $5.20 - $5
=$0.2
b) %Spread = (Spread/Ask price) x 100
= (0.2/5.20) x 100
= 0.0385 x 100
= 3.846%(approximately 3.85%).
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) using the formula;
Bid-Ask spread =Ask price - Bid price
Note: Bid Price = $8.40
Ask Price = $8.80
Bid-Ask spread = $8.80 - $8.40
=$0.4
b) %Spread = (Spread/Ask price) x 100
= (0.4/8.80) x 100
= 0.0455 x 100
= 4.545%(approximately 4.55%).
5. In one statement, which of the assets above has the higher liquidity and why?
Looking at the Spread of Crypto X =$0.2 and the Spread of Crypto Y = $0.4, we can see that the spread of Crypto X is smaller and when a spread is smaller it indicates higher liquidity. This is because, the buying and selling prices are close to each other and more trades are made. So, i can say Crypto X has higher liquidity.
6. Explain Slippage.
Cryptocurrencies are highly volatile assets and as such its price value is very unpredictable, because the price value of a cryptocurrency can change at any moment. The high volatile nature of cryptocurrencies can lead to a deviation of prices between the time a market order is made and when it is executed. From experience, sometimes when placing a trade with the current makert price, the placed order ends up to be an open order, with a change in the price different from the price you have already filled. The change between the expected price of a trade placed and the price at which the trade is executed is referred to as Spillage
With cryptocurrency, slippage is unpredictable as it can occur at any time, but is commonly experienced or seen during periods of higher volatility in the market. Spillage is also experienced in a trade, when a large order is being placed but volume of the asset in the market is enough volume, at the chosen price to maintain the current bid-ask spread, due to a wide Bid-Ask spread
To better explain what spillage is lets look at an example. For instance, meniya(a crypto trader) placed an order for 1 ADA at market price of $10, after which, meniya finds out that her oder has not been executed and the order is still open. This is because the price of ADA has just moved to $10.050, hence spillage has occured and her order can't be executed at that moment, except the market price comes down to the initial bid price of $10 or she cancels the order and take a new bid price. Therefore, the change in price from $10 to $10.050 is known as slippage.
Although spillage can be minimized or mitigated by
Changing the type of market orders
By traders not trading around major economic events.
When traders, trade in low volatile and highly liquid markets.
7. Explain Positive Slippage and Negative slippage with price illustrations for each.
▪︎Positive Slippage
A positive Slippage is a change in market price of an asset or commodity which favours a buyer or seller to their own advantage. A positive slippage occurs when a trader fills an order at a more favourable price.
For a buy order, positive slippage occurs when a trader fills an order at a lower price than intended and for a sell order, a trader fills an order at a higher price than he/she intended.
Illustration
For instance, trader Krisani place an order for TRX at $70 and the trade order was executed at $67, the Positive slippage would be; $70 - $67 = $3. Positive Slippage occured because the bid price of TRX changed to $67, leading to more profit for Krisani, as she will get more TRX coin.
And, if krisani(a trader) placed a trade to sell TRX at $98 and instead the trade was executed at $100, the Positive slippage would be; $100 - $98= $2.
Also, a positive Slippage has occurred for trader Krisani, as she will gain more profit from the sales of the same quantity of TRX coins.
▪︎Negative Slippage
A negative slippage is a change in market price of a commodity, which does not favor a trader, hence it leads to a loss(disadvantage) for the trader. A negative slippage is simply when an order is filled at a lesser price which is not favourable for a trader.
For a buy order, a negative slippage occurs when a trader fills an order at a price higher than he wished, and For a sell order, the trader fills a price lower than he intended.
Illustration
For instance, if a meniya (trader) placed an order to buy 2 STEEM coin at a market price of $1.0070 and instead the trade was executed at $1.0100 the negative slippage would be; $1.0100 - $1.0070 = $0.003. From this trade, meniya has incurred a loss of $0.003(negative slippage).
And if a trader meniya, fills sell order to sell STEEM with a price of &2.000 and ends up selling it at a price of $1.980, the negative slippage would be;
$2.000 - $1.980 = $0.02. Trader meniya has incurred a loss of $0.02 in this trade.
Thanks professor @awesononso for an informative class, looking forward to next class. Warm regards @meniya