In an auction, the “bid” is the price someone is willing to pay for an item. Of course, many individuals might bid for the same item, and the process can result in higher-and-higher prices for that item. Ultimately, someone makes a bid that no one else is willing to beat, and they become the owner of that item. On the seller’s side in an auction, a reserve price or a reservation price is the minimum amount that a seller will accept as the winning bid. This could be called the “asking” price.
Bid Ask Pricing for Stocks
When someone wants to buy or sell a stock or an ETF, they can enter a “market order.” When this is done, there is no “asking” price. But this approach is fraught with potential hazards. One is that if you the only buyer with a bid, and there is one seller, you might wind up paying the seller’s ask price. So, perhaps the shares closed yesterday at $50 per share. If you enter a market order for 100 shares, you might be thinking you will pay around $5,000 for the shares. However, if there is only one ask price for 100 shares, priced at $65 per share, you will pay $6,500 for 100 shares. For this reason, I rarely enter market buy or sell orders.
When Buying or Selling, Volume Matters
For heavily traded stocks and ETF’s, it might be OK to enter a market order. However, I rarely do that before the market opens or during the first hour of trading. I also avoid most trading during the last hour the market is open. My favorite time to enter an order is about one hour after the market opens. If I see the shares are trading rapidly, with over 1,000,000 shares traded in the first hour, and I like the current price, I sometimes enter a market order just to get the deal done. It is unusual for the price to vary much in a few minutes from the current price when these conditions are true.
Mutual Funds Are Different
If you are buying mutual funds, then you don’t have to worry about the price. Sadly, that could mean that you will be getting a price you don’t like. When you enter your order, you specify how much you want to spend. So, for example, if you have $5,000 in cash for a mutual fund purchase, you can specify that you only want $4,000 of the mutual fund. After the market closes, the final price of the fund shares will be calculated.
Suppose when the market opened that the overall market was down. You conclude that today is a good day to add to your mutual fund position because you can get shares at a better price. You enter your order for $4,000 of the fund at 9AM CST and move on to other tasks. However, at 2PM CST some great news is released by the Federal Reserve, and the market bounces up dramatically, closing higher at 3PM. Your order will be filled at the higher price, assuming the holdings in the mutual fund bounced in a similar fashion. That is a risk factor for every purchase of a mutual fund. Of course, the market could dive, and you might get a bargain. There are many “maybes” with this type of investment.
Entering Orders for ETFs and Stocks
As I said earlier, I rarely enter market orders. Instead, I enter what is known as a “buy limit order.” Before I do that, I consider three pieces of information. 1) I look at trading volume. If the volume is heavy, then the buy limit order price I am willing to BID might not be far from the current price. 2) I look at the range of prices others are willing to pay using the Fidelity Active Trader tool. If I am eager to buy (or sell) some shares, I might pick a price close to the current ASK price. 3) I consider a graph of the trading behavior of the ETF or stock during the past 90 days. Is the trend generally up or down? If down, then I might enter a smaller order to start with and add shares if the share price continues to drop.
A Word of Caution
The bid/ask situation on any given day or any time during a day can be colored by today’s economic news, an unemployment update, the President’s most recent tweet, a setback in the Covid-19 situation, bad news for a particular sector, and a host of other things. Furthermore, before I even get to a buy price, there are other decisions I make based on data. These data points include the P/E ratio, some dividend-specific values, earnings trends, and what the “experts” or analysts are saying. Price is just the price I am willing to pay after I have determined the investment is desirable.