CryptoAcademy Season 4 Week 1 / Homework Post for Professor @awesononso / Bid-Ask Price

Introduction

Hello Everyone,
It is my pleasure to be back again at the Academy. I am Kehinde Micheal and my username is @msquaretwins. I warmly welcome you all to this new season and more importantly to the week number one of this season. I hope you will have a great time at the academy this season. I am happy to be submitting my first homework in the dynamic beginners course which is on "The Bid-Ask Spread" presented by dynamic Professor himself, Prof. @awesononso. He has given detailed explanation of the aforementioned topic in a very clear and precise manner. Thank you Professor @awesononso. In this post, I will be answering the questions posted in the Homework section based on my understanding.

1. Properly explain the Bid-Ask Spread.

In trading, both the bid price and ask price set the tone for bid-ask spread. What do I mean by this statement? To fully understand the concept of Bid-Ask Spread, let first set the background for it by defining what bid and ask price are.

Bid price is the highest price possible a buyer choose to buy an asset or commodity at a particular period of time. And the ask price is the lowest price a seller is ready to sell an asset at a particular period of time.

The difference that exists between the two price mentioned above is what is known as Bid-Ask Spread. That is, the difference between ask price and bid price is called Bid-Ask Spread. Bid-Ask Spread is also called Spread

Mathematically, it can be expressed as;
A-B Spread = AP - BP
Where ;
A-B Spread = Ask-Bid Spread
AP =Ask Price
BP = Bid Price

Let check the screenshot below to see an example of Bid-Ask Spread on the chart

_{Screenshot Bid and Ask Price on TRXUSD Chart}

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As seen from the chart above, the bid price as indicated by a blue arrow is 0.09618 and the ask price which is indicated by a red arrow is 0.09683. The difference between ask and bid price( 0.09683 - 0.09618 = 0.00065) is called the Bid-Ask Spread.

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

Bid-Ask Spread is very important in the world of financial market and it importance can never be overemphasized as it helps to know or determine the behaviour of sellers and buyer at particular period of time.

More so, Bid-Ask Spread helps in determining the trading volume of an assets at particular period of time. For example, a low spread indicates that the gap between ask price and bid price is significantly small which is as a result of competition between many buyers and seller at a particular time. And as such, there is high liquidity in market at that particular time which then indicate the easy of trade execution due to the equilibrium of supply and demand. Traders often use this to their advantage to determine when to place their orders.

Also, when the difference between the ask and bid price is high, it indicate a very low liquidity in market. At this time, there are fewer sellers and buyers in market. This therefore means that the number of sellers and buyers determines how wide a spread will be.

In short, Bid-Ask Spread helps traders to the determine the liquidity of an asset in market at a particular period of time.

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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.) Parameters given for Crypto X are;
Bid price = $5.0
Ask price = $5.20
Bid-Ask Spread = ?
Recall;
Bid-Ask Spread = Ask Price - Bid Price
Bid-Ask Spread = $5.20 - $5.0
Bid-Ask Spread = $0.20

b.) Bid-Ask spread in percentage
The formula to calculate Bid-Ask percentage is;
% Spread = (Spread/Ask Price) x 100
% Spread = ($0.20/$5.20) x 100
% Spread = 0.0384615 x 100
% Spread = 3.8461%
:. %Spread = 3.84%

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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.) Parameters given for Crypto Y are;
Bid price = $8.40
Ask price = $8.80
Bid-Ask Spread = ?
Recall;
Bid-Ask Spread = Ask Price - Bid Price
Bid-Ask Spread = $8.80 - $8.40
Bid-Ask Spread = $0.40

b.) Bid-Ask spread in percentage
Recall, % Spread = (Spread/Ask Price) x 100
% Spread = ($0.40/$8.80) x 100
% Spread = 0.04545 x 100
% Spread = 4.5454%
:. %Spread = 4.55%

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

Crypto X has the higher liquidity than crypto Y.
The reason is that crypto X has low spread compared to crypto Y. Spread is used to determine the liquidity of an asset or commodity. The low spread indicates high liquidity and the high spread indicates low liquidity. As seen from the calculations above, crypto X has a spread of $0.20 and crypto Y has a spread of $0.40.

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6. Explain Slippage.

Slippage occurs in the orders that are placed at instant. Or simply put, It is associated with instant market execution orders. There is often a short interval of time between the time a trader initiated an instant order and the time the order is activated. Due to volatility of cryptocurrency, at this short interval, anything might have happened to the price a trader is willing to buy or sell an asset. Price might have changed from the intended point a trader is will to either buy or sell

Therefore, Slippage is an order action that occurs when an order is activated at a price different from the price at which a trader placed the order. Slippage majorly occur in a wide spread assets. I.e assets with low liquidity which is attributed to few sellers and buyers. And because of the few number of buyers and sellers n this case, there is always delay in matching. Hence, often result in slippage when orders are placed.

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

Positive Slippage

A positive slippage is one in which the other is executed at a price different from the intended Price but in favour of the order. For a buy order, a positive slippage means that the order is filled at a price lower than the intended price. For a sell other, the order gets to activate at a price above the price a trader placed the order.

Let's check the Illustration below for more clarity.
If a trader placed a buy order at instant market execution for Crypto A at $50 and the order activated at $49, Then the positive slippage for this buy order will give;
$50 - $49= $1

Also if a sell order is placed at a market price of $75 and the other get filled at different price say $82, the positive slippage for this sell is,
$82.0 - $75.0 = $7.0.

Negative Slippage

Negative slippage is the opposite of Positive slippage. In this type, the order placed is adversely filled at a price different from the intended price a trader will to execute the order. For a buy order, the negative slippage shows that the order is filled at a price above the intended price. And for a sell order, the negative slippage means that the other is activated at a price below the intended price.

As a way of illustration, let's assume a trader placed a buy order at an instant market price of $100 and the order got filled at a price of $104, the negative spillage would then be;
$100 - $104 = $4

Also, if a sell order is placed at an instant market price of $8.5 and the order activated at a market price of $8.2. Then the negative slippage will give;
$8.2 - $8.5 = $ 0.3

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Conclusion

From the lecture presented by Prof. @awesononso, I was able to know the importance of bid price, ask price and the difference between them which is the spread. More so, I got to know the concepts of liquidity as related to Bid-Ask Spread. Special thanks to Prof for this great and eyes opening lecture.