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What is a Spread?
A spread, is the difference between the Ask and Buy prices of a stock. As you know, the listed price of a stock, is not really of much interest to us. The spread won't normally be of any concern, when dealing with the higher dollar per share stocks. Because, they usually fluctuate many cents or even dollars a day. However when we're looking at Penny Stocks, it's a different story. Look at the chart of your typical dollar and a half stock. Better yet, one that is even less, say under a dollar. We'll use XYZ stock, notice that the stock (in this example) has an ask (buy) price of .66 a share and a bid (sell) price of .50.
That being the case, we can see that the stock has a spread of .16. So at the moment I buy it at .50, I can't sell it (without a loss, and this isn't even calculating in the commission expenses yet) until the bid price exceeds .66 (this means that the stock has to go up in price .16 just to get me that far.) Now notice that according to the chart, that the stock's price frequently starts out at .50 and may go as high as .88 in one day before falling again. On the surface this sounds like I could easily make a .33 profit per share. If I have 1000 shares that equates to $333.00 minus commissions of $40.00 and I still have an easy profit of $293.00.
This sounds good! But if I have checked out the spread, I've seen (before buying) that when the price on the chart is at .88. The bid (sell) price is only at .72 (.88-.16=.72) thus knocking my profit way down, which is far less than one might expect at first glance if not considering the spread. So in this example I bought the stock at .66 and then sold it at .72. That's .06 a share profit X 1000 shares = $60.00 minus the commissions of $40.00, leaving me with a $20.00 profit. Quite a difference from the $293.00 that I thought I would have gotten, before taking the spread into consideration.
The sell (bid) price is what you will be paid for the sale of the your stocks. The buy (ask) price is the price that you will pay to get the stock. The difference between the two, is pocketed by the market maker or brokerage house as part of their income.
If you go to the Stocks and Options page, and bring up a quote on any stock. You'll be able to see the Ask and Bid prices and be able to figure the difference between the two. You'll then find on the left side of the screen, a tab marked "Historical Charts." Click it and you'll see the chart, but first the quote MUST be requested.
A BIT MORE ON SPREADS...
For example: XXX does look like a good Roller on the three month historical chart, but when its spread of .375 is figured in we see our room for profiting is greatly diminished. The stock is a Buy @9.75, Sell @11. Which leaves a range for us to profit from of 1.25, agreeably this sounds alright. Now consider this…to buy the stock at 9.75 the listed price would have to fall to 9.375 or lower. Note that the spread must be calculated into where the listed price will be at, at the time we want to buy.
The same thought process is incorporated when diagnosing what the listed price and bid price differences will be when we're ready to sell @11. If we include the spread (which we must) the listed price will be 11.375 at the time the "bid" or our sell price is @11. Remember though, we don't expect the price to go as high as 11.375, we are predicting it'll crest @11. Therefore placing a sell @11. would be rather useless.
Okay! So now we've figured in the spread… What the end result brings to our attention is the fact that if we believe the stock is only going to fall to 9.75 and if we want to buy it at this predicted low…we probably aren't going to get it because the listed price will have to fall to 9.375 before our "ask" price or buy price is attainable. We're going to have to place our limit order to buy @10.125 to get this stock when it hits its predicted low of 9.75. If the spread was say….07 or perhaps .12 or maybe even zero, we'd then used those numbers for figuring instead. As it stands if we buy the stock at 10.125 and sell at 10.625 we actually only have a range of .50 to make any profit in. Big difference from 1.25 isn't it?
I'm pointing this out to highlight the importance of including the spread into our equations of buying and selling. It is true also that the spread can change throughout the Trading day and from day to day as well. So whether the spread is making a situation look good or bad right now, it may by its change in size, cause a completely different situation in a short time.
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