Bid ask spread is the amount (in rupees or paise) by which the best ask rate (lowest sell price) exceeds the best bid rate (highest buy price) of a security at any given moment.
It is used for trading and to read an order book. The lower the bid ask spread, the higher the chance of a transaction between the buyer and seller.
If the best ask rate is Rs 5,252 and best bid rate is Rs 5,250, then the bid ask spread is Rs 2.
On a trading day, at any given moment, in a security’s trade order book (refer table), there will be a list of different bid rates or prices and different ask rates or prices of different bidders and sellers, respectively.
Source: Tavaga Research
Bid rates are arranged highest to lowest, ie. the highest buy price (most beneficial for a potential seller, hence best bid price) to the lowest buy price (least beneficial for a potential seller), quoted by bidders for that security. Ask rates, on the other hand, are arranged from the lowest sell price (most beneficial for a potential buyer, hence best ask price) to the highest sell price (least beneficial for a potential buyer).
Once a trade is done, the rates in the queue climb up the order book.
In a liquid market, with high trading volume (ie. large number of units or securities being traded) the bid ask spread is low, as there are many buyers and sellers. So, bid ask spread may tell us how liquid a security is, as the lower the bid ask spread the more liquid the security.