What is Bid Price?
Bid Price is the price quoted by a buyer to buy a particular stock or security or any financial instrument and this bid same is placed against the ask price quoted by a particular seller selling that particular stock or security or financial instrument.
For successful bidding the ecosystem requires a seller, a buyer, a stock and an ask price. The ecosystem of trading requires a buyer to place his/ her price. Depending upon the ask price, the buyer places the order.
Examples of How Bid Price of Shares Work
Let’s take some examples.
Example #1 – A Bull Market Scenario
Suppose Mr. X wants to buy a stock of ABC limited at a price of $20 per share. However, the prevailing rate is $22.5 and it is coming to $21.70 and the price is not sustaining in that rate. While Mr. X wants to take exposure to the company. Thus, the asking price at which the seller wants to sell is $22.5 and a low of $21.70. Thus, to make the transaction happen Mr. X can revise its rate to $21.7 and can observe if the transaction happens or not? Maybe he has place order at $21.7, but due to sudden increase in demand, the price shoots up to $23 per share. Now, the ask price has become $23 per share and to match the ask price, Mr. X has to place the bid higher than its last bid price.
Example #2 – A Bear Market Scenario
Mr. Joseph wants to buy shares of Netflix @ $288 per share. While the prevailing rate of Netflix is $ 292. Mr. Joseph would test by placing the bid price at $285 per share. Whereas due to bear market dynamics, other bidders will place the bid price at $286-288 per share. Thus, the lower bidding will allow the price to an inch below $290/ share, break down the $290 price range. The seller might experience that the price did not come to the desired levels. Due to bearish market dynamics the seller would force to sell the security at $286-288 levels or may be lower than that.
- Helps to provide the quote the price, which the buyer is willing to pay for a particular security or stock.
- The seller would be informed about the value of the security held by him. A higher bid price than the ask price is an indication of good stock and vice versa. However, in the real situation, the ask price always stays above the bid price as the expectation of the seller from his stock is always more while the buyer always quotes a lesser price for the particular stock.
- The intrinsic value of the security can be determined. Though, the general sentiment during the bull market remains positive as the buyer is ready to purchase at a higher price as they know the particular stock can be sold at a further higher price.
- In the case of the bear market, the general perception of the buyers remains low while the seller is willing to sell the security at a lower price. Thus, the buyer can find the seller easily. While in the real market condition the perception remains so low that the bid price tends to get lower.
- When a bid price matches with the ask price, the transaction happens. In most of the cases, they remain low unless a bunch of buyers willing to buy the stock at a given point of time. Thus, in other words, the bid and ask price depends on the demand-supply theory. The higher the demand, the higher the bid.
Disadvantagesof Bid Price
Some of the disadvantages are as follows:
- This price is lower than the ask price and sometimes it hindered the transaction as the seller is not willing to sell the security as quoted in the bid price.
- Through bid price, the real value of the securities cannot be determined. Due to market dynamics, investors sentiment, fear of the bear market, they tend to get lower. However, the actual price of the stock might be quite high and the seller is forced to sell its security at a lower price due to liquidity crunch.
- In modern-day trading, the bidding is placed through electronic systems. There are millions of transactions occurring each day. Thus, it is impossible to contact the bidder or the buyer. The seller and the buyer can’t meet each other.
- Through bid, the buyer wants to purchase the specific security, while the real value might not be the same. Due to liquidity crunch, the bidding price of the stock or the security has gone down and it might not reflect the actual fundamental of the stock.
- The bidder places the price below the price quoted by the seller through ask price. However, it always remains below the ask price. The phycology behind the mechanism is that the purchase rate should be lower than the ask rate.
Limitations of Bid Price
Some of the limitations are as follows:
- They do not replicate the actual value of the security. It is just the scenario of market dynamics.
- The bidder will always bargain, due to lower demand the seller may sell at a lower price.
- The difference between the bid price and ask price is called the spread. The higher the spread, the higher the bargaining power of the bidder.
- However, as per the market perception, It is taken as the benchmark, while in many cases the price might be lower than the intrinsic value of the security.
- It is placed by the buyer.
- Remains below ask price.
- The seller does not meet buyers physically.
- The difference between the bid and ask price is called spread.
- Does not always determines the intrinsic value of the security.
- The market looks for the stock’s performance through bid.
In modern days, the electronic trading platform has replaced the age-old cry system of trading. Both the bid and ask price comes in front of the screen and traders can trade accordingly.
This has been a guide to what is bid price and its meaning. Here we discuss how bid prices work along with examples, limitations, advantages, and disadvantages. You can learn more about shares from the following articles –