I thought it would be prudent to create a post outlining some criteria for Bid/Ask spreads and what to look for to protect yourself from getting screwed by the market makers.

Let’s Look at an Example

Click To Enlarge

Click on the image above to open it in a separate window and put it off to the side so you can reference it while reading through this article.

You will see that this is a screenshot of a real-time Level II quote screen for PeakStocks.com Spotlight company AuthenTec (Nasdaq: AUTH). I took this screenshot to illustrate the bid/ask spread, but don’t worry if you don’t have access to this information, you can still make sound trades using the techniques that I will outline below.

Notice the BID price on the left, and the ASK price on the right.

The BID Price:

Essentially, the BID is the price at which a buyer or market maker is willing to buy a security.

If you owned shares in a stock, say AuthenTec, and wanted to sell, it is the current price at which someone is willing to purchase your shares.

You may not be happy with this price, especially for thinly traded Small-Cap and Micro-Cap stocks because a lot of times, these stocks are illiquid and market makers tend to create a huge discrepancy between the BID and ASK spread so as to make more money from you.

The ASK Price:

Essentially, the ASK is the price at which a seller or market maker is willing to sell a security.

If you wanted to buy shares in AuthenTec, this price would be the current price at which someone is willing to sell you their shares.

Again, you might not be happy with this price, especially in lieu of the much lower BID price.

The BID/ASK Spread:

This is the difference between the highest price that a buyer is willing to pay for a security (BID) and the lowest price for which a seller is willing to sell it (ASK).

The current bid price is $15.20 per share if you wanted to sell shares, with 100 shares beings sought out (the 1 signifies 100 share increments). So if you had 100 shares of AUTH, and wanted to sell right now, someone would be willing to purchase those shares for $15.20, and your order would execute immediately if you used a market order.

If you wanted to purchase shares, there are 300 available for $15.23. So if you wanted to purchase up to 300 shares, your order would execute immediately also using a market order.

The Bid/Ask spread is only $.03, which represents about a .197% difference, statistically insignificant, so if you really wanted to get some shares, you wouldn’t mess around, and just purchase them at the ask price to make sure you got them.

What Happens If…

What happens, using the example above, if you wanted to SELL more than 100 shares?

Well, this is when you might run into problems, and might have to take a lower price.

100 of your shares would sell at $15.20, but then the next order is at $15.17 for 300 shares, meaning that your next batch of shares would more than likely fetch a lower price.

You are seeing the laws of supply and demand and market economics at work!

Because the stocks that PeakStocks.com deals with are thinly traded like these, you have to be careful when purchasing large blocks of shares, as the bid/ask spread becomes a factor.

Likewise, if you wanted to BUY more than 400 shares of this stock (there are 2 buyers lined up at $15.23), the next offer to sell is at $15.50! Ouch…that’s a long way to go!

More than likely however, the market maker would never let the price go that far, and would step in at a price that would allow them to make some profit (they would take both sides of the trade), and not allow such a precipitous rise or fall in the stock.

This is why you MUST use limit orders at all times, especially with these kinds of stocks.

It might take some time to fill, but you are protected from not getting the price you specified and prevent the market makers from dictating to you what price they are willing to buy and sell a security for.

Now let’s look at an extreme case…

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