Bid-Ask Spread — The Hidden Cost of Every Trade

Definition

The bid-ask spread is the difference between the bid price (the highest price a buyer is willing to pay) and the ask price (the lowest price a seller is willing to accept) for a security at any given moment. It represents an immediate, unavoidable transaction cost — the moment you buy at the ask and could only sell at the bid, you are already at a loss equal to the spread.

The spread is the price of immediacy. If you want to trade right now, you pay the spread. If you are willing to wait, you can post a limit order and potentially get a better price.

How It Works

The Order Book

SELL (Ask) side:          BUY (Bid) side:
───────────────           ───────────────
105.20 × 500 shares       103.80 × 300 shares
105.00 × 1,200 shares     103.60 × 800 shares
104.80 × 2,000 shares     103.40 × 1,500 shares

Best ask: 104.80           Best bid: 103.80
Spread: 104.80 − 103.80 = 1.00 PLN (0.95%)

Spread Calculation

Absolute spread = Ask price − Bid price
Percentage spread = (Ask − Bid) / Ask × 100

Mid-price = (Ask + Bid) / 2
Percentage spread (alt) = (Ask − Bid) / Mid-price × 100

What Determines Spread Width

Real-World Spread Examples

Example

A Polish investor wants to buy 200 shares of Allegro (ALE) on the GPW:

Current order book:

Best ask: 32.50 PLN
Best bid: 32.30 PLN
Spread: 0.20 PLN (0.62%)

Scenario A: Market order (immediate execution)

Buy 200 shares at 32.50 PLN = 6,500 PLN
Immediate mark-to-market value (at bid): 200 × 32.30 = 6,460 PLN
Instant loss from spread: 40 PLN (0.62%)
Plus brokerage commission: ~10 PLN (0.15%)
Total entry cost: 50 PLN (0.77%)

Scenario B: Limit order at 32.40 PLN

Order placed, waiting...
If filled: 200 × 32.40 = 6,480 PLN
Saved vs market order: 20 PLN
Risk: order may not fill if price rises

Impact on Round-Trip Cost

To buy and then sell, you pay the spread twice:

Buy at ask:  32.50 PLN
Sell at bid: 32.30 PLN
Round-trip spread cost: 0.20 × 2 = 0.40 PLN per share (1.23%)
Plus commissions: ~0.30% round-trip

Total round-trip cost: ~1.53%

This means Allegro needs to appreciate by at least 1.53% before you break even on a trade. For a day trader, this cost is devastating. For a long-term investor who holds for years, it is a one-time friction.

GPW vs. Major Exchanges

The same company can have very different spreads depending on the exchange. For dual-listed stocks or ETFs, checking spread differences can save meaningful amounts on large orders.

Why It Matters for Investors

The True Cost of Trading

Brokerage commissions are visible and well-understood. The spread is invisible but often larger. On the GPW, a typical round-trip brokerage cost is 0.3%, but the round-trip spread on a mid-cap stock can be 1-2%. The spread is the larger cost.

ETF Selection

When choosing between two similar UCITS ETFs, the one with tighter spreads may be better even if its TER is slightly higher. For an ETF you trade once, a 0.05% TER difference saves 0.05% per year, but a 0.10% tighter spread saves 0.10% immediately.

Execution Timing

Spreads widen at market open, near close, and during volatile periods. Placing orders during mid-session (11:00-14:00 CET on GPW) typically gets tighter spreads.

Market Quality Indicator

A widening spread on a stock you own can signal deteriorating liquidity or upcoming negative news. Market makers widen spreads when they perceive higher risk.

Freenance helps you track your actual execution prices against mid-market prices, so you can see how much spread cost you are paying across all your trades.

Risks and Pitfalls

1. Market orders in illiquid stocks — On a stock with 0.5 PLN spread and thin depth, a large market order can "walk the book," filling at progressively worse prices. Always use limit orders on illiquid GPW stocks.

2. Ignoring spread in performance calculations — If you calculate returns using mid-prices or closing prices, you overstate actual performance. Your real buy price was the ask; your real sell price was the bid.

3. Spread widening during crises — During the March 2020 COVID crash, spreads on normally liquid ETFs widened 5-10x. Selling during a panic means accepting terrible prices on both the spread and the level.

4. Catalyst bond market — Poland's Catalyst (corporate bond exchange) has notoriously wide spreads, often 2-5%. This means a "6% yielding" corporate bond effectively yields 4% or less after buying at the ask, especially for small positions.

5. Forex spreads — Currency conversion spreads at retail banks can be 2-4% (e.g., PKO BP's kantor). Online platforms like Wise or Interactive Brokers offer 0.01-0.05%. The difference on a 50,000 PLN conversion is 1,000-2,000 PLN.

6. Penny stock traps — A stock trading at 0.50 PLN with a 0.02 PLN spread has a 4% spread. Even a small absolute spread becomes enormous in percentage terms for low-priced stocks.

FAQ

Why do some ETFs have tighter spreads than their underlying stocks? Authorized Participants (APs) and market makers compete to provide liquidity for popular ETFs. For a UCITS ETF like VWCE trading on Xetra, multiple market makers quote tight spreads because the ETF creation/redemption mechanism limits their risk.

Does the spread go to the broker? No. The spread goes to the counterparty — the person on the other side of your trade. In practice, market makers capture most of the spread as compensation for providing liquidity and bearing inventory risk. Your broker earns the commission separately.

Should I always use limit orders? For liquid blue chips (PKO BP, KGHM), market orders are fine — the spread is minimal. For anything on GPW with daily volume under 1 million PLN, always use limit orders. On Catalyst bonds, never use market orders.

What is a "crossed spread"? When the bid exceeds the ask (e.g., bid 105, ask 104), it means a trade should execute immediately. This happens briefly during rapid price movements and is typically resolved within milliseconds by the exchange's matching engine.

Related Articles

• Arbitrage — Profiting from Spread Discrepancies Across Markets
• Blue Chip Stock — Where You Find the Tightest Spreads
• Liquidity — The Force That Determines Spread Width