As the saying goes, 'it takes two sides to make a market'. The two sides concerned are:
- Buyers, who usually believe an asset's value is likely to rise - known as 'bulls';
- Sellers, who generally think an asset's value is set to fall - known as 'bears'.
The relationship between them powers the movements in market prices. Let's look at how that works.
Suppose you were buying a car – you'd look for the lowest price on the model you wanted. And if other buyers were thin on the ground you might strike a good deal. On the other hand, if you were trying to bag a rare and sought-after vehicle, you might have to pay the seller a high price. In the same way, the balance of demand from buyers and supply from sellers influences prices in financial markets.
The spread
So why do different prices apply for buyers and sellers?
The gap between the bid and ask prices occurs because buyers and sellers often have contrasting views about the value of an asset:
- The bid price is the highest price at which a buyer is prepared to buy;
- The ask price is the lowest price for which a seller is willing to sell.
The difference between the two prices is known as the 'spread', and also as the 'bid-ask spread' or 'bid-offer spread'. The spread may also incorporate a broker's fee for handling the trade. The broker quotes clients a price slightly lower than the fundamental bid price or slightly higher than the ask price, keeping the difference to cover its costs.
