### Investors often overlook this key trading expense.

Jan 15, 2016 at 12:22AM

Stock exchanges work by bringing together buyers and sellers. When two parties agree on a price, a trade goes through. To facilitate trades, financial institutions take on the role as market-makers for stocks, posting two different prices, a lower one at which they'd be willing to buy the stock, and a higher one at which they'd be willing to sell it. The highest price at which a market-maker will buy the stock is known as the bid, while the lowest price among those willing to sell is called the ask. The interval between those two prices is the bid-ask spread.

For the most liquid stocks, the bid-ask spread can be extremely small. For example, Apple shares typically trade with a bid-ask spread of just a single penny per share. However, for stocks that don't have as much trading volume, you'll typically see wider bid-ask spreads of a nickel or more per share.

Why a percentage calculation is important
Notice that the true cost of the bid-ask spread doesn't have anything to do with the price of the stock but rather only with the number of shares and the size of the spread. What that means is that a penny-per-share bid-ask spread on a \$10 stock will have a much larger relative cost than the same spread on a \$100 stock.

To calculate the bid-ask spread percentage, simply take the bid-ask spread and divide it by the sale price. For instance, a \$100 stock with a spread of a penny will have a spread percentage of \$0.01 / \$100 = 0.01%, while a \$10 stock with a spread of a dime will have a spread percentage of \$0.10 / \$10 = 1%.

Many investors never notice the bid-ask spread, but it's a real cost that you'll need to overcome in order to earn a profit on your investment. The bid-ask spread percentage gives a good indication of how liquid a stock is and how much danger there is in using market orders to buy and sell shares for your portfolio.

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Feb 1, 2016 at 5:03PM

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