New investors are often understandably confused by how stocks are priced. The bewildering truth is that in many cases there are two prices, mysteriously called the bid and ask. The discrepancy results from the fact that stock is always being bought and sold. From the investor's viewpoint, the bid is the price when selling, and the ask is the price when buying.
Imagine the person you're buying from. This person actually exists in the form of a market maker, a professional from whom investors buy and sell. A market maker is simply a product distributor, and stock is the product. Like any other distributor, a market maker earns money by marking up the cost of the product. Since market makers buy and sell this product all day, they price it differently depending on whether you are buying or selling. Obviously, they charge a higher price to buy stock from them, and offer a lower price for stock you want to sell to them.
The difference between the bid and the ask is called the spread. It is sometimes possible to beat the spread (buy stock lower than the ask price, or sell stock higher than the bid price) by placing a limit order between the two prices. In a volatile marketplace, the prices are always jumping around, but they remain tied to each other. In high-volume stocks, the spread is small, sometimes just 1/16 of a point which is .06
There is a thrilling moment of empowerment before you make your first online stock purchase. You are playing in the market right there alongside the big boys of Wall Street. Before you set the wheels in motion by clicking that on-screen button, there are some basic decisions to make.
Are you using a market order or limit order? Market orders direct the brokerage to buy and sell stock at prevailing prices as soon as you place your order. Limit orders define the price you're willing to pay or receive. When placing a limit order, you must decide whether it should expire if not filled by the time the market closes (a day order, or good for the day), or should remain open until you manually cancel it (a good till canceled order). (Note: Most online investors use limit orders as a matter of course, never placing a market order into a volatile stock market. Limit orders should be strongly considered when buying volatile stocks, and can't hurt when buying in calmer waters. Market orders, by contrast, can hurt very much if your broker executes your trade at a price much higher than you expected.)
Article was written by wallman
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