SteemitCryptoAcademy [Beginners' Level] | Season4 Week1 | The Bid-Ask Spread

It is amazing to be part of this new season's homework. Thanks @awesononso

Properly explain the Bid-Ask Spread.

Bid-Ask spread is simply the quantity or amount with which the ask price is higher than the bid price. Basically, it is the difference between the highest price a buyer is ready to purchase an asset and the least amount a seller is ready to give out his asset. The seller gets the bid price while the buyer makes payment for the ask price. Hence, it is a demand-supply relationship for an asset and is used to measure the liquidity of the market. When the bid price and ask price expands apart further, the price action will depict a change in the demand and supply.

The depth of both bid and ask can have a great impact on the bid-ask spread. The spread will likely become wider if there are fewer people who place limit orders to buy an asset or fewer sellers who place limit orders to make sales. As a result, a participant must have the bid-ask spread in mind when placing a limit order to buy a certain asset to ensure that the transaction is carried out successfully. Professional traders and those who understand the risk of market may attempt to widen the difference between the best bid and ask as they would make more profit by exploiting the changes in the spread.

What influences Bid-Ask Spread?

The primary cause of bid-ask spread is Liquidity. The spread becomes tighter with higher liquidity. On this note, stocks such as google, apple, etc that are traded heavily usually have a smaller spread. In addition, a spread may be high to unpopular securities such as small-cap stocks with lower trading volumes and lower demand.

Example of a Bid-Spread

Take for instance that a trader is looking to purchase 50 shares of Microsoft for $30. He then sees the number of shares he desires but at $30.5 in the market. The Bid-ask spread would now be $30.5 - $30 or $0.5 wide.

From the screenshots above, it is evident that the bid side is the green wave while the red wave is the ask. The gap between both waves is very minimal and that is the Bid-Ask Spread.
It invariably means that ADA/BTC and LUNA/BNB have good number of limit orders from both sides of traders (buyers and sellers). It increases the trading volume of the market and adds to the liquidity.

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

The Bid-Ask spread is important in the market for the following reasons;

1. Bid-Ask Spread is an indication of the direction of the market movement. Traders know what to do when it narrows or widens and can tweak the market accordingly.

2. It is a measure of the trading risk of the asset. Every trader wants to buy or order a stock at the best possible price and the higher the price, the higher the risk in trading.

3. It serves as a guide to the best kind of order to place. When the spread is narrow, one can get the best price with the market order.

4. Bid-Ask Spread is a meter to know the liquidity of any asset or stock. Pricing gets better and changes hands when the liquidity of the stock is high.

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.

a.) For Bid-Ask spread of Crypto X

Solution:
The bid price = $5
The Ask price = $5.20
Bid-Ask Spread = Ask price - Bid price
=$5.20 - $5
=$0.20

b.) Bid-Ask spread in percentage

Solution:
% Spread = (Spread/Ask Price) × 100
= (0.2/5.20) × 100
= 0.0385 × 100
=3.85%

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.

a.) For Bid-Ask spread of Crypto X

Solution:
The bid price = $8.40
The Ask price = $8.80

Bid-Ask Spread = Ask price - Bid price
=$8.80 - $8.40
=$0.40

b.) Bid-Ask spread in percentage

Solution:
% Spread = (Spread/Ask Price) × 100
= (0.40/8.80) × 100
= 0.0455 × 100
=4.55%

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

Crypto X relatively has the higher liquidity. Liquidity simply means how easy it would be to trade an asset. Higher liquidity simply equals low bid-ask spread and this is what crypto X has.
Crypto X is said to be a more liquid market because the bid-ask spread is smaller than that of crypto Y, it is easy to be traded and the trading volume is presumed to be high.

Explain Slippage.

Slippage is the difference in the expected price of a stock and the price at which it was actually sold. Slippage is more prevalent during moments of high volatility when market orders are utilized although it can occur at any given time. It can also be seen when a larger market order is carried out and there is no sufficient volume to maintain the current spread at the chosen price.

When a buy or sell order is placed by a trader, it is expected that the order be filled at the chosen price and when it’s not, it is called slippage. It simply means that the trader received a different trade price from what he intended. It is worthy to note that slippage happens in literally all market venues such as equities, forex, stocks, futures, etc.

Example of slippage

A popular way in which slippage happens is usually as a result in the change in the bid-ask spread. An order place may be executed at lower or higher price than intended. It is negative when the ask becomes higher in a long trade and positive when the ask decreases in a long trade. This can be avoided by placing limit orders.

For instance, say Microsoft bid/ask prices are posted as $50.20/$50.25 on the broker interface. 50 shares are placed as a market order with an expectation that it fills up at $50.25. Before the order is placed, however, events change, and microsecond transactions by computerized programs reduce the bid/ask spread to $50.15/$50.20. As a result, the order fills out at $50.20, resulting in a positive slippage of $0.05 per share.

Explain Positive Slippage and Negative slippage with price illustrations for each.
A slippage doesn’t always have to be negative as it can sometimes be positive.

Positive slippage

A positive slippage like I demonstrated earlier in the example above refers to a situation where an order is filled below the intended price at a more favourable price. For a sell order, a positive slippage can be seen when the order is filled at a price higher than the intended whereas for a buy order, a positive slippage can be seen when the order is filled at an amount lower than intended.

For instance, Mr. Ade places an order for UNISWAP to be bought at $35 and instead, the trade was carried out at $33. This can be said to be a positive slippage because Mr. Ade has just saved $2 ($35 - $33 = $2).
If he also decided to place a sell order on the same UNISWAP for $38 and it was rather executed $39, it is also called a positive slippage because he gained $1 extra ($39 - $38 = $1).

Negative slippage

A negative slippage occurs when a market order is filled at a price higher and less favourable than expected. For a sell order, a negative slippage happens when the order is executed at a price lower than expected while for a buy order, a negative slippage is seen when an order is filled at a price higher than expected.

For instance, if Miss Simi placed a market order to buy BTC at $47 and the trade was executed at $47.50, a negative slippage of 0.50 has occurred ($47.50 - $47 =$0.50).
Furthermore, if she placed a market order to sell the same BTC at $50 and it was sold at $48, the negative slippage is $2 ($50 - $48 =$2).

Conclusion

Bid-ask spread can be used in the stock market and financial market and is simply the difference between the highest price a buyer is ready to purchase an asset and the least amount a seller is ready to give out his asset. Crypto traders can understand how it works to their own advantage and makes good profits. Slippages are not only negative as a lot of people think but can also be positive and favourable to a trader. Being knowledgeable about this concept is advantageous to any trader.

cc: Prof. @awesononso