Understanding the phenomenon of bids and asks, primarily within the scope of financial markets, is essential knowledge that every individual interested in trading or investing in stocks, commodities, or even cryptocurrencies must acquire. At first glance, one might believe these terms to be the most straightforward; however, they play a fundamental role in how any transaction is executed and how prices are determined within a financial market.
Thus, if a trader is on Indian stock exchanges or NSE (National Stock Exchange) or BSE (Bombay Stock Exchange), he would like to have a fair idea of how the whole system operates, especially when working in forex or commodity markets. He will come to know the concept of bids and asks while trading on exchanges.
In this post, we‘ll try to break down the concept of bids and asks in the Indian context. We will discuss what they are, how they work, and how they can affect your trades and investments in India‘s financial markets.
What Are Bids and Asks?
The bid and ask, also called the offer, are terms used in the context of financial markets for the prices that are acceptable to buyers or sellers. In this light, the two prices make for an interaction between buyers and sellers in the market a continuous one.
Offer Price: The price the buyer would pay for a given asset, like equity, bond, or commodity. This is the demand for that asset.
Offer to Sell Price: The lowest at which a seller will sell an asset. It highlights the supply side of the market.
For a sale and purchase to occur, the bid and ask need to be close enough to each other so that they produce a trade. The difference between the bid and the ask is called the spread. Spread is an important indicator of market liquidity and efficiency.
Thus, in India, whether a person trades equities, derivatives, commodities, or foreign exchange, understanding bids and asks will help him understand how the transactions are executed on the exchanges.
The two biggest stock exchanges where buyers and sellers meet are the NSE (National Stock Exchange) and the BSE (Bombay Stock Exchange) in India.
Both the bid price and the ask price would exist for each listed stock. They appear real-time on the exchange platform. The prices change as the demand and supply dynamics play out in the market.
With the example of Reliance Industries Ltd. stock prices, the above might apply
Bid Price: ₹2,200
Ask Price: ₹2,205
Now you can sell your Reliance equity shares for the bid price of ₹2,200. But, if you wish to buy, then you have to pay the ask price of ₹2,205. The spread is the ₹5 difference between the bid and the ask price.
2. Commodity Markets
In commodity markets, bids and asks are almost like in the share trading context. The example of gold trading would be as follows:
Bid Price: ₹56,000 per 10 grams
Ask Price: ₹56,050 per 10 grams
If you were a buyer of gold at the MCX, you would pay at the ask price of ₹56,050. Similarly, if you were a seller, you would get the bid price of ₹56,000. The spread in commodities is different; it depends on various factors such as demand, supply, and volatility in the prices of global commodities.
3. Forex Market
The Indian forex also borrows the concept of the bid and the ask price. Suppose you are trading the USD/INR currency pair:
Bid Price: ₹83.00
Ask Price: ₹83.05
The price at which you can sell USD and buy INR is known as the bid price. To find out how many of them you can buy, you’d put in the BID and then adjust the quantity according to your requirement. Similarly, the price at which you can buy USD and sell INR is called the ask price. The ₹0.05 spread between the bid and the ask is the cost of trading in this pair.
How Do Bids and Asks Affect Your Trades?
The difference between the ask and the bid price, also known as spread, plays a crucial role in controlling the cost of a trade. Here‘s the background:
1. Transaction Costs
The spread is actually a ‘stealth’ cost for traders and investors alike. If you want to buy an asset, say a stock, you would pay at the ask price, which is higher, of course, than the bid price. Thus, in case you resolve later to sell the same asset, then, due to the spread, you will sell at the bid price, which again is lower than the ask price. So, when you come in and go out of a trade, then you will incur a cost equivalent to the spread. This is particularly important for short-term traders or those who indulge in buying and selling with great frequency.
In the Indian market, the spread size varies on the basis of asset liquidity. For instance, liquidity-based stocks of large companies, such as Reliance, Tata Consultancy Services (TCS), and Infosys have tight spreads, but for small stocks or any low trading volume stock, the spreads are pretty wide, raising the cost of purchase and sell orders.
2. Market Liquidity
Therefore, the width of the spread is a good proxy for market liquidity. For instance, large-cap stocks or highly traded commodities have narrower spreads. The spread in these markets would be relatively small; that is, the difference between the asked price and the bid price will be lower. Small-cap stocks or less traded commodities would be examples of less liquid markets. In such markets, the spread may be larger.
The highest trading volumes are yielded by the most liquid markets. For instance, the most liquid stocks are those representing the Nifty 50 index, such as HDFC Bank, ICICI Bank, State Bank of India, etc. These have narrow bid-ask spreads. In contrast, small or low trading volume stocks have relatively wider spreads.
3. Impact on Slippage
Slippage is a situation in which the fill price for your order is different from what you view when entering the order in terms of trading. It might be caused by a fast-moving market between the time when an order is placed and the time when that order gets filled.
These shares will spread over a wider range, increasing the chances of slippage, particularly in volatile markets. In India, slippage can occur in case of some significant announcements related to corporations or any government declarations, like quarterly earnings reports or budget announcements. It can be shown that understanding the spread could help one to predict slippage and act according to this knowledge to further amend the trading strategy.
4. Types of Orders
Since traders could place different types of orders, based on the type of the bid and ask prices, in a manner similar to other markets, India also experienced this.
Market Order: It is one where the asset is bought or sold at an immediate marketplace using best available prices. For instance, when one issues a market order to buy a stock, he or she pays the ask price. Conversely, if one gives a market order to sell, then he or she gets the bid price.
Limit Orders:
It is an order to buy or sell at a specific price, or better. As you would want to buy a certain stock, but only at or below the current bid, so you input a limit buy order. Similarly, if you want to sell a certain stock, but only at or above the current ask price, you make a limit sell order.
Stop Orders:
These are orders that become activated once a particular price level is reached. A stop-market order, as soon as the stop price is reached, would trigger a market order, and a stop-limit order would trigger a limit order at a specified price as soon as the stop price is attained.
How to Apply Bids and Asks in India‘s Strategies
The trader in Indian markets uses bid and asks while making their decisions. Here are some things that you should keep in your mind:
1. Keep an Eye on Narrow Spreads
If you’re a day trader or a scalper, you need narrow bid-ask spreads because they help you complete the transaction faster and cut transaction cost as well. You will typically find narrow spreads in the blue-chip stocks or heavily traded Nifty 50 stocks.
If you are not pressing for the execution of a trade, you can use a limit order to help control the price at which you buy or sell. That way, you will ensure that your trade is only executed at a price you are comfortable with and do not get your trade executed should the market move against you when you’re forced to pay for the ask price or take the bid price.
2. Liquidity Analysis
Before opening a trade, observe the liquidity based on the bid and ask spread of the stock or asset. Widely spread might show low liquidity, and you could reconsider or wait for more favorable conditions.
Conclusion
In the Indian financial markets, the terms “bid” and “ask” describe how and when transactions take place and how market prices are determined. Whether or not you are trading stocks, commodities, or even forex, knowledge of the nature of the bid-ask spread will help you make smarter and more cost-effective trading decisions.