In simple terms — The bid is the best displayed price from a buyer; the ask is the best displayed price from a seller. Their difference is the quoted spread. The price actually received may be better or worse than those quotes, so the cost of an execution cannot be inferred from the spread alone.
The bid-ask spread is the distance between the best buying price (bid) and the best selling price (ask or offer) available for an instrument in a specific market at a specific time. Its elementary definition is:
quoted spread = best ask − best bid
The calculation is meaningful only when both quotes belong to the same informational scope: the same instrument, currency, venue or set of venues, timestamp, and trading conditions. In fragmented markets, the best bid and best ask may come from different venues. In an over-the-counter market, they may depend on the dealer, requested quantity, and client relationship.
Bid, ask, and midpoint
The midpoint is the arithmetic mean of the best quotes:
midpoint = (best bid + best ask) / 2
If the bid is 99.98 and the ask is 100.02, the midpoint is 100.00 and the quoted spread is 0.04. Relative to the midpoint, the spread is 4 basis points:
relative spread in bps = spread / midpoint × 10,000
A market buy normally trades against the ask side; a market sell trades against the bid side. This does not mean that the full order quantity is available at the best quote. If size exceeds displayed depth, the order may cross several levels of the order book and receive an average price different from the top of book.
A market may also be locked, with bid equal to ask, or crossed, with bid above ask, because of market structure, fragmentation, feed delays, or temporary conditions. Such observations require explicit data-handling rules; they are not negative spreads that should automatically be treated as executable opportunities.
Three measures, three questions
| Measure | Reference | What it describes |
|---|---|---|
| Quoted spread | best ask minus best bid at a timestamp | distance between displayed quotes |
| Effective spread | execution price relative to a reference midpoint | execution price cost, doubled to make it comparable with a spread |
| Realized spread | execution price relative to a later midpoint | component retained by the liquidity provider after a defined horizon |
Under the convention used by the SEC for execution-quality statistics, the effective spread of a buy is twice the difference between execution price and midpoint. The sign is reversed for a sell:
buy effective spread = 2 × (execution price − midpoint)
sell effective spread = 2 × (midpoint − execution price)
The midpoint and timestamp must be those prescribed by the methodology. U.S. Rule 605, for example, uses definitions tied to orders and securities covered by that rule. It is not a universal regulatory formula for futures, FX, cryptoassets, or OTC instruments.
The realized spread replaces the initial midpoint with one observed after a specified interval. It is primarily used to examine the price movement after a trade and the potential adverse selection borne by the liquidity provider. It is not the trader's profit, does not necessarily include fees and hedging costs, and changes when the measurement horizon changes.
Example: quoted spread and execution price
Using a 99.98 bid and 100.02 ask:
- the quoted spread is 0.04, or 4 bps relative to the 100.00 midpoint;
- a buy executed at 100.01 receives 0.01 of improvement over the ask;
- its effective spread is 2 × (100.01 − 100.00) = 0.02, or 2 bps;
- its one-way cost relative to the midpoint is 0.01, or 1 bp.
The “half-spread” rule of thumb holds only when an order executes exactly at the best quote and the midpoint is the symmetric mean of bid and ask. An immediate buy at the ask followed by an immediate sell at the bid would instead cross the full quoted spread, before fees, market movement, and available-quantity effects. Price improvement, multi-level fills, and quote changes during routing alter the result.
This distinction also prevents double counting. If slippage is measured against the midpoint, crossing the spread is already included in that deviation. Adding the spread again as a separate cost would overstate the loss.
Why the spread changes
The spread compensates for several costs and risks involved in supplying liquidity:
- the risk that price moves while a quote remains exposed;
- the risk of trading against a better-informed order;
- inventory and hedging costs borne by a market maker;
- volatility, uncertainty, and the speed at which information changes;
- tick size and other market rules;
- competition among liquidity providers;
- depth, order size, and time of day;
- venue-specific costs, incentives, and fees.
Saying that a market maker “earns the spread” is therefore incomplete. The participant may capture a difference between purchases and sales but also bears inventory risk, adverse selection, hedging, technology, and fees. The realized spread may be much smaller than the quoted spread or even negative.
A tight spread often indicates good tightness—a low cost to trade a small quantity near the midpoint. It does not establish that the market has enough depth for a large order or that liquidity will recover quickly after a shock. Those are separate dimensions of liquidity.
Data limitations
The value shown by a platform may represent the latest quote received, only the selected venue, or an indicative price. A Level 1 feed does not show depth beyond the best quotes. Hidden liquidity, iceberg orders, and venues excluded from the feed remain outside the snapshot. The size associated with bid and ask may also change before an order arrives.
Comparing spreads across instruments or periods requires at least:
- stating whether spread is absolute, percentage, or basis points;
- identifying the venue and feed;
- defining the session, time window, and sampling frequency;
- specifying the quantity to which the measure refers;
- documenting the treatment of locked, crossed, or missing quotes;
- reporting means, medians, and percentiles rather than one snapshot alone.
Comparing a stock quoted in dollars with a futures contract quoted in index points is not useful when only absolute units are used. To estimate the spread's contribution to transaction costs for a specific size, quotes must be combined with depth, fills, and actual fees.
Common mistake — Treating the displayed spread as a certain total cost. It measures quotes within a defined scope; the outcome also depends on size, order type, latency, depth, venue, and chosen benchmark.
Sources
- SEC, Investor.gov — Bid Price/Ask Price
- SEC — Frequently Asked Questions: Rule 605 of Regulation NMS
- SEC — Release No. 34-43590, Disclosure of Order Execution and Routing Practices
- BIS, Committee on the Global Financial System — Structural Aspects of Market Liquidity from a Financial Stability Perspective