Reading Market Depth & Why It’s Important
Understanding market depth is an essential skill for both investors and traders. This lesson targets beginners, focusing specifically on the “Bid” and “Ask” prices commonly seen in brokerage apps. But what do these terms mean exactly?
In Simple Terms:
- Bid: The Bid price represents the highest price a buyer is willing to pay for a stock. Think of it as a bid at an auction. If you place a bid at the market price, the price at which sellers are willing to sell, your trade will go through, and you will own the stock. Otherwise, your bid remains pending until a seller agrees to your price.
- Ask: The Ask price represents the lowest price a seller is willing to accept for a stock. It’s the opposite of a bid. This is the lowest price someone is willing to sell their stock for, waiting for a buyer to meet their price.
For those who understand the intricacies, great. For everyone else, let’s dive deeper.
The Bid & Ask Stack
Every sell order above the market buy price remains an “Ask,” and every buy order below the market sell price remains a “Bid.” The Bid and Ask stack up, creating the market depth.
- Ask: Comprises all shareholders trying to sell.
- Bid: Comprises new or existing shareholders trying to buy.
The highest Bid and lowest Ask create what we call the Bid-Ask spread, which is the difference between the buying price and the selling price of the stock.
- Bid = Highest price the market will buy your stock for (sell price).
- Ask = Lowest price the market has shares available for (buy price).
Example: Bid-Ask spread = Bid $0.405 & Ask $0.42.
This means the highest price someone is willing to pay for the stock now is $0.405 (Bid), and the lowest price someone is willing to sell it for is $0.42 (Ask). If you want to buy the stock now, you would have to purchase it at the Ask price of $0.42.
How Market Depth Affects Stock Prices
A stock price is determined by the last trade. So if you buy the stock at $0.42, even though the app showed $0.405, the new stock price will be $0.42.
You can track all these Bids and Asks in real time to know exactly how many shares you can buy or sell at what price.
Market Depth Display
In market depth displays, you can see all the willing buyers’ Bids and all the willing sellers’ Asks. For example, if there are 35,000 shares on the bid at $1.30 and 4,500 shares on the ask at $1.40, buying 4,500 shares at $1.40 would clear the Ask and push the stock price up to the next available Ask price.
Impact of Buyer and Seller Behavior
- Influx of buyers: The Ask gets bought out and moves to higher prices, increasing the stock price.
- Influx of sellers: The Bid gets sold into and moves to lower prices, decreasing the stock price.
Avoiding Overpaying with Market Depth
Be cautious with market orders to avoid overpaying for a stock, especially in illiquid markets where the spread can be large. Always know the number of shares available at each Bid and Ask price.
Thin Bids & Thin Asks
A thin Ask indicates low selling resistance, where little buying could cause significant price increases. Conversely, a thin Bid indicates no price support, where little selling could cause significant price decreases. Ideally, look for stocks with stacked Bids and thin Asks, indicating strong support and potential for price increases.
Conclusion
Understanding the Bid and Ask, along with market depth, can significantly enhance your trading and investing skills. This knowledge allows you to anticipate price movements and make more informed decisions.
Thank you for reading.
Disclaimer: This is not financial advice.
If you enjoyed this lesson and want to dive deeper into the world of trading, head over to Alphainews’s Learn Articles for more comprehensive articles and tutorials. Moreover, you’ll find expert insights and strategies to enhance your trading knowledge and skills.
