I understand that in an Order driven market, there is no market maker and traders transact with other traders, and prices are determined by demand and supply.
In Quote-driven market, Bid and Ask spread is set by market maker and it is the profit for the dealer. However, I am confused in an Order driven market, where does the bid and ask spread come from? Since there is no market maker, and in Economics the equilibrium of demand and supply will have only one equilibrium price. The Toronto Stock Exchange is an example of Order-driven market, but I checked there is still quote of bid/ask when trading stock from TSX. I don’t understand here what are they stand for? Why there is still bid/ask spread?
When looking at stock quote on financial website, there is only one value, what is the relationship to bid/ask price? And if I bought stock and want to calculate returns, should I use the current bid or ask price, or the single price quote?
I know Bid/Ask spread is a indication of liquidity, high bid/ask price means low liquidity, but could someone help elaborate more on the reason the logic behind it?
Given a Bid/Ask price for a stock, if a limit buy order is to be used, what are the strategies to determine the optimal limit price such that the order will be filled (not at a price that is too low) but not at a price that is too high?
Hi, the bids and asks in the order driven market comes from the investors who wants to purchase the security and use limit orders. So for example, if I have a brokerage account and wanted to buy ABC. I would enter a limit order for 100 shares at $9.99/share. This then creates a bid at $9.99. If another person wants to buy ABC and enters a limit order for 100 shares at $10.00/share, then $10.00 is the current highest bid and that’s the bid you will see in a quote. Likewise, if I had 100 shares of ABC and wanted to sell them at $10.01 per share, I would enter a limit order to sell 100 shares at $10.01 / share. If the current highest bid is $10.00, then my ask for $10.01 is the lowest ask and it is the ask that you will see in a quote. Now, if someone else wanted to sell and place a limit order to sell at $10.00, then that order will be matched with the order that wanted to buy at $10.00 and a trade is consummated. The single price quote that you see is the last traded price. If you bought stock and wanted to calculate returns, the proper way to do it is to use the bid price. This is because that is the highest price someone is willing to pay for your shares at that moment. The last traded price is no longer relevant.
With bid/ask spread, the larger the spread, the less liquid. Think of the last example. For liquid stocks, it means that there’s a lot of people that are willing to buy and a lot of people willing to sell. So the bid may be at $10.00 and the ask is $10.01. This is a small spread. If the stock was not liquid, there won’t be many people wanting to buy and there won’t be many people wanting to sell. If I wanted to buy, I may only put in a bid of $9.80. If someone wanted to sell, they may only be willing to sell at $10.20. If we are the only two buyer and seller, then the bid/ask is $9.80-$10.20. The spread is $0.40 instead of $0.01. Again, if this were a liquid stock, then more people will be willing to bid at higher prices, such as $9.90, then someone else will come along and say I’m willing to pay $9.95. Similarly, if there are more sellers, then someone may be willing to sell at $10.10 and another person will come along and say, I’m willing to sell at $10.05. As you can see, more buyers and more sellers will drive the bid up and the ask down. This increases the likelihood of a match between bid and ask, and would then result in a trade.
I don’t know if there’s such a thing as an optimal limit price. If you want guaranteed execution, then you would use market order. If not, then the optimal limit price is the highest price you want to pay for that security. It may or may not be executed.