Why is there a Large Difference in Bid and Offer Prices?

Why is there a Large Difference in Bid and Offer Prices?

At the beginning and end of every trading session, you may have noticed that there is usually a significant disparity in the prices being offered by buyers and sellers of shares. You will also notice, these prices are typically much greater than and much lower than the indicative opening or closing price shown on your screen. However, when the opening or closing trade goes through, many of those orders have been filled and a significant volume of shares may have traded. These factors are all interrelated and it’s part of an important process that every investor should understand.

 

What are ‘Bid’ and ‘Offer’ prices?

First things first, if you’re new to investing in shares, it’s probably a good thing we cover what these terms mean. A ‘Bid’ is the price that is chosen by a buyer when they want to purchase shares. On the other hand, the ‘Offer’ price, sometimes called the ‘Ask’ price, is the price at which the seller is offering to sell their shares. During trading hours, bids and offers will typically ‘meet’ one another and result in trades being executed.

 

 

The opening and closing ASX auctions

While the majority of the trading session allows buyers and sellers to execute immediate trades at the prevailing market price, there are two important periods where ‘auctions’ dictate the price that market participants will receive when a trade is executed. One of these auctions is the first 10 minutes of the trading session, whereas the other is the final 10 minutes of the trading day.

It’s also worth noting that if a company releases a price-sensitive announcement or goes into a trading halt and resumes trading during the session, that can also lead to a third scenario involving an auction.

During the opening and closing ASX auctions, all bids and offers are matched up and the overlapping volume will be traded. The process for this involves an algorithm that weighs up the total volume on the buy side against the total volume on the sell side to determine the crossover in the middle, referred to as the ‘match’. In effect, the algorithm measures supply versus demand, such that a weighted mid-point is identified as the ‘auction’ price for all volume sold.

 

Opening auction

At 10am Sydney time, normal trading will commence on a staggered basis. The opening 10 minutes serve as an auction period, however, the auction for each stock will take place according to distinctive groups categorised alphabetically as shown below. Bids and offers may be submitted into the market any time from 7am Sydney time, with the first normal trade(s) conducted as part of each auction. The opening time for each of these groups of stocks is randomly generated and occurs up to 15 seconds either side of the times shown. Keep in mind that if a company submits a price sensitive announcement shortly before the start of the trading day, the opening auction will be delayed.

 

Share Code

(starting with)

Trading commences
(Sydney time: +/- 15 seconds)
A-B 10:00:00 am
C-F 10:02:15 am
G-M 10:04:30 am
N-R 10:06:45 am
S-Z 10:09:00 am

 

Closing auction

At 4pm Sydney time, the market will move into a second auction phase, beginning with a period called the Pre-CSPA (Closing Single Price Auction). This period allows orders to be placed, amended or cancelled. However, no trades will be executed until a random time between 4:10pm and 4:12pm, at which point the Closing Single Price Auction takes place. In some instances, such as the last business day before Christmas and the last business day of the year, trading will conclude at 2pm Sydney time. The Pre-CSPA would run until 2:10pm, with the CSPA occurring between 2:10pm and 2:12pm.

 

 

Explaining large differences in Bid and Offer prices

If there are no bids that meet the offer price of sellers, then no volume will be traded. The stock price will remain where it previously traded. Should a buyer lift their bid price to meet the lowest ask price, then the trade will be done at the ask price. Similarly, if a seller reduces their offer price to meet the highest bid price, the latter is the price at which a trade will be executed.

The above scenario mostly takes place with smaller illiquid stocks. This is because larger cap shares generally command significant volume that results in an opening or closing trade. With large companies, there is such a surplus of overlapping volume, ‘priority’ is afforded to the buyers who bid the highest and sellers who offer stock the lowest.

Therefore, if you have ever wondered why some people bid for stock at a higher price than the indicative opening or closing price, or offer to sell stock at a price that is well below the expected auction price, it is because of the way overlapping volume is matched. These individuals are at the front of their respective ‘queues’, which means that their bid or offer is executed first. What’s more, the trade does not necessarily occur at the price they have submitted, it occurs at the overlapping mid-point.

 

Placing orders

Whether you should place your bid or offer above or below the indicative auction price ultimately depends on how eager you are to buy a stock or sell your existing shares. This is a personal consideration that should be reflected upon as part of your investment thesis in every trade.

If priority matters, rest assured knowing that when it comes to figuring out whether your order is likely to be fulfilled, priority is always given to those who ‘bid’ the highest or ‘ask’ the lowest. In fact, even if you have an order already sitting in the queue, you could be pipped to the post by someone who was prepared to pay a higher price or sell for a lower price, despite the fact the stock may open or close at the price you nominated.

 

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SelfWealth Ltd ACN 52 154 324 428 (“SelfWealth”) (Australian Financial Services Licence Number 421789). The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. Taxation, legal and other matters referred to on this website are of a general nature only and should not be relied upon in place of appropriate professional advice.

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