Bid

What is a bid price?

In financial services, the term bid definitionis used to describe the collective action of a stockbroker placing a stake on a security, most notably, stocks. The bid not only consists of the amount of stock required but also the maximum price the broker is willing to pay for the purchase in question.

It is important to state that the bid definition is different from the asking price - often simply referred to as 'ask' or 'asked'. The latter is the minimum acceptable price required to purchase the stock, while a bid can be higher or lower than the ask. The two are often used in conjunction with each other but it is important to establish the clear differences between them.

A purchase is secured when the seller finds the bid agreeable or the buyer adjusts the bid to match the ask price quoted by the current owner of the securities or stocks. The difference between the lowest price that the seller is willing to accept and the highest that buyer is willing to pay is known as the spread. Bid price definitions therefore can be concluded as the price bid on a particular security.

Where have you heard about bid price?

Bid and ask prices are regularly used to refer to any security which can be bought and sold on the stock market – most commonly shares. They are an integral part of trading infrastructure and are key terms you should be comfortable with before making a foray into the financial sector. The terms make clear the requirements and intentions of both the seller and the buyer and assists in easing the negotiating process between both parties.

Third party companies called market makers are often involved in mediating between the buyer and seller. As well as being expert negotiators, they can also absorb some of the risk involved with trading by holding the stock themselves before selling it at the best price possible. Market makers are sometimes referred to as liquidity providers due to their ability to bring greater market stability and provide liquid capital to a range of stakeholders.

What you need to know about bid prices

The bid is crucial to the market maker, as the difference between the bid and ask, also known the spread is the profit accrued by the sale of the asset.

A bid price will often fluctuate depending on the intention of the buyer. For example, if the buyer is looking to purchase a security with an ask price of £10, they would pay £10 if they weren't looking to make an instant profit. This would be the case if somebody was looking to purchase the stock for a long-term game. An investor, on the other hand, would look to purchase the asset for £9.50 in order to sell the security at £10 and make a profit. In this example, the spread, or profit, would be £0.50.

The percentage margins between the bid and ask prices can fluctuate greatly depending on the health of the stock market. If the economic markets are going through a period of fiscal turbulence, then investors will be cautious about paying too much while sellers will be reluctant to let their stock go below what they think it was previously worth.

You may hear reference to the liquidity of stock and shares. In short, liquidity is the speed and ease which an asset, of any kind, can be sold. Money is considered to be high in liquidity due to the ease which you can exchange or sell it. Securities are extremely mercurial and while they have greater liquidity than say, for example, a piece of furniture, they are not immune from the turbulence of the financial markets.

Liquidity is closely related to the spread – the difference between bid and ask. The closer the ask and bid prices are, the smaller the spread and the greater liquidity of the security. The closer the buyer is willing to go to the asking price, the more valuable the security is and thus has more liquidity as it can be quickly sold on if required. It is important to remember that the spread price does not reflect real term value and it is likely to change in the coming days, weeks, months and years.

Limit orders are a specific way of executing sales and purchases with bid and ask provisions. You simply set a limit for the price that you want your security to either be sold or the price you are willing to pay to acquire it. If you set a bid limit of £100 then you will never pay more than this for your security – it is entirely possible that you will even pay less. If you are the seller, then setting an ask price limit order of £100 means that this figure is the minimum for which your security can be sold.

Limit orders can also be used to purchase securities when they reach a particular value. If you have a specific interest in purchasing a number of, for example, Facebook stocks, you might want to implement this transaction infrastructure.

For instance, if the stocks are currently selling at £150 and your monetary limit is £120, set your bid price to your maximum budget. Once the ask price comes within your bid range you can then buy them at your desired value. The same is true for selling, if you have an interest in retaining the security if it falls below a certain value. Set your ask price for £130 and it will never be sold for less, even if the market causes the value of the stock to crash below this in real terms.

It's important to note that a bid price is only true for the specified number of securities. If you bid £100 for 500 units, it does not mean that 1000 units will cost you the same. If you want to acquire 100 units from a seller or market maker, in theory, you should be able to come in with a lower bid offer. Paradoxically, this is not always the case. If a liquidity provider has excess securities which they are seeking to expunge, selling a significant proportion of the units means they are fewer available and may, in turn, make them more valuable on the financial markets.

Volatile markets are prone to increasing the spread, and thus the risk, and can alter the bid definition. This is actually a valuable tool for the investor who otherwise might well avoid the purchase after deeming it too risky. Blue-chip and large-cap stock normally have the narrowest difference between the bid and askprice. This is purely down to the fact that with the more expensive stock the percentage difference goes much further than in a micro-cap company. For investors buying small time stocks, they must purchase huge sums for them to see and value from any spread at all.

Find out more about bids...

Those seeking more information about the functionality of the bid system can take a look at our glossary. If you want to know a little more about how the bid system can impact your overall trading approach, then this article from the Investor Guide looks at how marketing uncertainty can impact the spread and reduce or increase your risk.