The Bid-Ask Spread: Market Liquidity and the Hidden Cost of Every Trade

The cost of the bid-ask spread is not an obvious cost associated with every transaction; nonetheless, all traders incur this hidden cost when buying or selling. The gap between what a buyer is prepared to pay and what a seller is prepared to accept is called the bid-ask spread or spread, and understanding this gap is key to understanding how financial markets work.

The bid price is defined as the highest price a buyer will pay to buy a security, while the ask price is defined as the lowest price a seller will accept to sell that security. A market intermediary (market maker or dealer) earns the difference between the bid and ask prices as part of their compensation. Market makers earn this fee since they support the financial marketplace by providing ongoing prices to market participants by constantly quoting bid and ask prices, thereby providing liquidity to investors. This keeps the marketplace operating even in circumstances when buyers or sellers are not willing to complete the trade at the time requested. The cost of this service, the bid-ask spread, is not considered to be a form of market inefficiency, but it serves as compensation to the market makers for taking on the risk of holding inventory and adding value to the marketplace.

Bid-Ask Spread as a Signal of Liquidity

The bid-ask spread is a direct measure or proxy for market liquidity. A narrow spread indicates that there are many traders clustered around a price point with buyers and sellers actively competing against one another in the marketplace. Conversely, a wide spread implies that there are few traders creating liquidity, so price uncertainty is greater and costs of making trades are also higher. In highly liquid markets, traders compete with each other to buy or sell financial products, which produces a narrow bid-ask spread. The Bid Price is the price at which someone wants to purchase an asset, whereas the Ask Price is the price at which someone is willing to sell the same asset. Typically, a trader wishing to sell their asset at the market price will be forced to sell at the highest `Bid Price` and will, therefore, pay the difference ('Spread'). In scenarios where a trader has limited liquidity available to them from suppliers, the cost of dealing with this liquidity shortage will delay how quickly and accurately prices reflect the changing information regarding that asset. The increasing size of  Spreads` during periods of `Liquidity Stress` indicates that there is not enough capacity within financial markets to efficiently pass through pricing information. This widening of Spreads occurred during `Market Disruptions` caused by the announcement of `US Tariffs` in April 2025, and resulted in notable volatility across both currency and fixed-income markets.  It further created several negative economic impacts beyond the daily losses incurred by traders.

The `Bank for International Settlements` published, in 2025, its Triennial Survey that showed the average global daily turnover in Foreign Exchange was $9.6 trillion. This represented a 28% increase when compared to the average daily turnover of $7.5 trillion in April 2022. The massive trading volume has kept Bid/Ask Spreads for the major currency pairs, especially the `EUR/USD`, extremely narrow, usually less than a fraction of a pip wide. The competition between `Liquidity Providers` to gain access to customer order flows has allowed the `Bid/Ask Spreads` of the most liquid instruments to fall towards zero.

The inverse relationship between the amount of activity occurring in a market and the width of the `Bid/Ask Spread` can be seen equally across all electronic products that are traded (i.e. `Derivatives`, `Contracts for Difference`, `Futures`, and `Equities`). It also underscores how platform technology can provide an advantage to retail trading providers. Retail brokers now compete on a number of dimensions, including the price of their online trading platforms, and some brokers are even starting to offer zero pip spreads on the most highly traded instruments, a figure that would have been highly unrealistic if the markets were still being conducted via voice brokers.

Another broader economic argument can be made about how the separate markets operate, with each of them providing liquidity at very low bid-ask spreads. When pricing in a foreign exchange market or other high-volume markets by means of electronic trading occurs at a very low bid-ask spread, pricing better reflects a market participant's response to new information about the underlying asset, and results in a lower trading cost for the market participant. However, the more important economic argument is that liquid markets with low bid-ask spreads will direct capital to its most productive use at a lower cost and with less friction; one of the chief purposes of an efficient financial market is to provide an efficient channel for transferring capital to productive uses.