Bid-Ask Spread
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Last updated
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The Bid-Ask Spread indicator is a common metric used in markets to measure liquidity. This is calculated the following way:
Bid-Ask Spread = Ask price - Bid price
It can also be calculated as a percentage:
Bid-Ask Spread = (Ask price - Bid price)(Ask price + Bid price)/2
This is a measure of liquidity as the bid-ask spread reflects the cost market takers incur from buying at the ask price or selling at the bid price.
Bid-Ask Spread is one of the main metrics to gauge the liquidity of a market. If bid-ask spreads are relatively high, that is a sign that the market is relatively illiquid. On the other hand, low bid-ask spreads are a positive indicator of high liquidity.
For traders, lower bid-ask spreads are preferable all else being equal. This is the case as crossing the spread (e.g. buying at the ask or selling at the bid) has a lower transaction cost when the difference between the ask and bid price is small. For this reason, IntoTheBlock aggregates the 30-day average bid-ask spreads to help traders know where they can obtain the lowest transaction costs (excluding fees).
Another important factor to consider is how to interpret spikes in the bid-ask spread. Sudden spikes in the bid-ask spread imply a short-term loss in liquidity, which tends to be due to high orders taking liquidity away from the order book, high volatility or a mix of both. Sudden spikes in bid-ask spread are worth taking into account as this decrease in liquidity tends to exacerbate price action. In other words, if price is dropping and the bid-ask spread spikes, the price drop is likely to be amplified at least in the short-term.
