The bid-ask spread is the difference between the highest price buyers are willing to pay (bid) and the lowest price sellers are willing to accept (ask) for a security. This small gap impacts every trade, influencing costs, liquidity, and market sentiment.

Here’s why it matters:

• Costs: You always buy at the higher ask price and sell at the lower bid price, so the spread is an immediate cost. For frequent traders, these costs can add up quickly.
• Liquidity: Narrow spreads indicate high liquidity and stable markets, while wider spreads suggest lower liquidity or higher volatility.
• Price Discovery: Spreads reflect the ongoing negotiation between buyers and sellers, helping determine an asset’s fair value.

For traders in Singapore, understanding spreads is crucial for improving trade execution, managing risks, and interpreting market conditions. By focusing on liquid assets with tight spreads and timing trades during active hours, you can minimise costs and improve profitability.

How Bid-Ask Spreads Work

Getting a handle on bid-ask spreads can help traders make smarter decisions and better manage their trading costs. This spread is a key part of market structure and touches every transaction.

Calculating the Bid-Ask Spread

The formula for the bid-ask spread is straightforward: Ask Price − Bid Price = Spread.

To make comparisons across different securities or price levels, traders often express the spread as a percentage. For example, if DBS Group Holdings has a bid price of SGD35.20 and an ask price of SGD35.25, the absolute spread is SGD0.05. When calculated as a percentage of the mid-price (SGD35.225), the spread comes out to 0.14%. Now, contrast that with a stock trading at SGD2.50 on the bid and SGD2.55 on the ask. Here, the same SGD0.05 spread equals 2.0% of the mid-price – a much higher percentage cost.

One important thing to note: lower-priced stocks often have higher percentage spreads, even with the same absolute spread. Timing also plays a role since spreads tend to tighten during peak trading hours and widen during quieter periods, like the opening and closing minutes of SGX sessions.

Mastering these calculations is the first step to understanding how market makers and order books influence spreads.

Market Makers and Order Books

Market makers play a crucial role in keeping the market liquid. They do this by constantly quoting bid and ask prices, ensuring trades can happen smoothly and quickly. Meanwhile, the order book records all pending buy and sell orders at various price levels. When you place a market order, it gets matched with the best available price in the order book. Limit orders, however, sit in the queue at your chosen price, and if they become the best bid or ask, they can help narrow the spread.

During Singapore’s trading hours, market makers adjust their quotes based on factors like the asset’s volatility, their inventory levels, and overall market conditions. For instance, if a market maker has too much inventory, they might lower their bid prices and raise their ask prices to balance their holdings. The depth of the order book also matters – a thin order book with fewer shares at each price level usually leads to wider spreads, while a deep order book with lots of volume supports tighter spreads.

Transaction Costs and Spreads

Every trade comes with an immediate cost: the spread. When you buy, you pay the ask price; when you sell, you receive the bid price. This means every position starts with a cost equal to the spread.

For frequent traders, these costs can add up quickly. Take a day trader who executes 25 round-trip trades each month on stocks with an average spread of 0.20%. Over a year, that trader would face spread costs totalling 120% of their trading capital (25 trades × 12 months × 0.20% × 2 for round trips).

High-liquidity markets, like SGX’s blue-chip stocks, typically have tighter spreads. For example, STI component stocks often trade with spreads between 0.05% and 0.15% during active hours. On the other hand, smaller-cap stocks or those with low trading activity may have spreads of 1% to 3% or more, making them less appealing for short-term trading strategies.

Being aware of these dynamics is critical when choosing what to trade and deciding when to enter or exit positions. At Collin Seow Trading Academy, managing spread-related costs is a key part of their trading education, helping traders keep more of their profits intact. These principles also highlight how bid-ask spreads can serve as useful market indicators.

Bid-Ask Spreads as Market Indicators

Bid-ask spreads serve as a window into market conditions, reflecting the balance of supply and demand. They act as early signals for shifts in investor sentiment and overall market dynamics. For traders, understanding these spreads can significantly improve timing and risk management, while also providing insights into liquidity and market behaviour.

Liquidity and Spread Size

Liquidity and spread size share a close relationship that’s crucial in trading. Stocks with high liquidity, such as popular SGX-listed shares, often have narrow spreads. These tighter spreads lower transaction costs and make it easier for traders to enter or exit positions smoothly. On the other hand, less liquid stocks, like many small-cap shares, tend to have wider spreads. This is because market makers demand higher compensation for taking on the increased risk associated with these stocks.

Spread sizes also fluctuate with trading activity. For instance, spreads usually widen during market openings or closings when uncertainty is higher. Conversely, during peak trading periods, spreads tend to narrow, reflecting increased market confidence and activity.

Market Volatility and Spread Changes

Volatility plays a significant role in how spreads behave. When uncertainty spikes – whether due to breaking news or sudden market shifts – market makers often widen spreads to protect themselves from rapid price movements. This adjustment is a tell-tale sign of growing unpredictability in the market.

Economic events specific to Singapore, such as quarterly GDP reports or announcements from the Monetary Authority of Singapore, can also temporarily impact spreads. Recognising these patterns allows traders to fine-tune their strategies, helping them steer clear of higher transaction costs during volatile times.

Reading Spread Changes

Bid-ask spreads can be a barometer of market sentiment. For example, narrowing spreads paired with rising prices can signal increased confidence and active participation in the market. On the flip side, widening spreads might suggest uncertainty, reduced activity, or anticipation of significant news or events.

The context of these changes matters. For instance, spreads narrowing during high trading volumes may indicate strong market momentum, while the same movement in a quiet market might not carry the same weight. By analysing these shifts, traders can avoid overreacting to short-term fluctuations and make more informed decisions.

At Collin Seow Trading Academy, traders learn to integrate spread analysis into their broader strategies. This approach not only helps them manage costs effectively but also improves trade timing. By understanding and interpreting spread changes, traders enhance their ability to navigate the market and uncover valuable opportunities.

Bid-Ask Spreads in Price Discovery

Now that we’ve explored how spreads reflect market liquidity and sentiment, let’s dive into their direct role in shaping market prices. The bid-ask spread plays a key part in price discovery, as it represents the ongoing negotiation between buyers and sellers to determine fair value.

How Bid and Ask Prices Shape Market Prices

Price discovery happens when buyers’ bids meet sellers’ asks, resulting in trades that set the market price.

This interaction occurs thousands of times during a trading day on the Singapore Exchange (SGX). Market makers are essential players in this process, constantly quoting both bid and ask prices to ensure there’s always a market for securities. They earn profits from the spread while providing liquidity to other participants.

The midpoint between the bid and ask prices often serves as a benchmark for fair value, especially in highly liquid markets. For example, if a stock’s bid price is S$10.00 and the ask price is S$10.02, the midpoint of S$10.01 is considered the theoretical fair value. However, the actual transaction price depends on whether the next trade involves buying at the ask or selling at the bid.

An order book with significant depth – where many orders are placed at various price levels – supports tighter spreads and more efficient price discovery. On the other hand, shallow order books lead to wider spreads, making price discovery less reliable. These effects are even more evident in markets with lower liquidity.

Price Discovery in Low-Liquidity Markets

Low-liquidity markets bring unique hurdles to price discovery. With fewer participants and infrequent trades, determining fair value becomes more complicated. Small-cap stocks on the SGX often face such challenges, where days might pass without meaningful trades, making it tough to pinpoint fair value.

In these markets, wider spreads are a sign of greater uncertainty. Wider spreads in illiquid stocks reflect the higher risks market makers face when holding positions they can’t easily offload. This can discourage trading activity and further reduce liquidity.

Timing is especially critical in low-liquidity environments. A single large order can significantly shift prices, as the order book may lack the depth to absorb the trade without affecting prices. For traders, analysing spreads becomes even more crucial to minimise market impact.

Private markets and over-the-counter (OTC) securities face even steeper price discovery challenges. Without continuous two-way quotes, fair value often relies on periodic transactions or comparisons with similar assets. The lack of real-time bid-ask spreads makes valuation more subjective and prone to inaccuracies.

Learning the Dynamics of Price Discovery

To truly grasp price discovery, traders need both education and hands-on experience. Understanding how bid-ask spreads interact with market forces helps traders make smarter decisions and improve execution.

Collin Seow Trading Academy offers specialised courses that explain how bid-ask spreads influence market conditions and create trading opportunities. Through live webinars and practical examples, traders can learn to interpret spread behaviour across various scenarios.

The academy’s resources, including The Systematic Trader v.2, explore how spreads relate to market efficiency. Participants are taught to distinguish between spreads that signal genuine price discovery and those that indicate temporary market imbalances, potentially revealing profitable opportunities.

The focus is on practical skills rather than just theory. Traders learn how different order types – like market orders and limit orders – interact with the bid-ask spread. They also gain insights into timing their trades to minimise costs and maximise the advantages of efficient price discovery.

Free e-courses and video content from the academy provide valuable tools for navigating different market conditions. By understanding how price discovery works, traders can better evaluate whether current prices reflect fair value or present trading opportunities. These insights enable them to time their trades more effectively, improving their overall results.

Trading Strategies Using Bid-Ask Spreads

Understanding bid-ask spreads isn’t just about knowing market mechanics – it’s about using that knowledge to trade smarter. By analysing spreads, traders can reduce execution costs and improve profitability. Spread analysis serves as both a cost management tool and a signal for market timing.

Trading Assets with Narrow Spreads

Narrow spreads are a hallmark of liquid markets, making it easier and cheaper to enter or exit positions. For instance, blue-chip stocks on the Singapore Exchange (SGX), such as DBS Group Holdings, Singapore Telecommunications, and United Overseas Bank, often have spreads as tight as S$0.01 to S$0.02 during regular trading hours.

Trading these liquid assets offers more than just lower costs. Tight spreads mean you’re not starting at a disadvantage due to the bid-ask difference. Even a small price movement can cover the cost of the spread.

Timing matters, too. Aim to trade during peak hours – between 10:00 AM and 3:00 PM – when spreads tend to be at their narrowest. Avoid the first and last 30 minutes of the trading session, as spreads often widen during these times due to heightened volatility and reduced liquidity.

To further optimise costs, consider using limit orders. Instead of immediately accepting the ask price, place your buy order at the midpoint or slightly above the current bid. With highly liquid stocks, your order is likely to be filled as spreads fluctuate throughout the day.

Managing Spread Changes in Volatile Markets

Volatility can cause spreads to widen quickly, as market makers adjust their quotes to manage risk. For example, during the market turbulence of March 2020, SGX stocks that usually had spreads of S$0.01 saw them expand to S$0.05 or more.

Spreads can act as an early warning system. If you notice spreads widening across several stocks, it often signals growing uncertainty and potential major price movements. This insight gives you time to rethink your strategy, reduce position sizes, or postpone non-urgent trades.

During volatile markets, be cautious with order types. Market orders can become costly as they force you to cross wider spreads. Instead, use limit orders to control costs, even if it means waiting longer for execution. If you must trade, set more aggressive limit prices to ensure execution while still avoiding excessive spread costs.

For large trades, consider scaling in gradually. Break your order into smaller parts, executing each as spreads tighten. This approach reduces the overall cost of wide spreads while allowing you to build your position over time.

Finally, keep an eye on spreads returning to normal levels. When spreads stabilise, it’s often a sign that market conditions are calming down, which may present better opportunities to execute trades you previously delayed.

Learning Resources for Better Trade Execution

If you’re looking to deepen your understanding of these strategies, there are excellent educational resources available. For example, Collin Seow Trading Academy provides a range of tools, from structured programmes to live webinars, all designed to help traders integrate spread analysis into their decision-making.

The academy’s Systematic Trader Program focuses on incorporating spread costs into risk-reward calculations. This ensures that potential profits outweigh execution costs, a critical skill for any trader.

Live webinars offer real-time demonstrations of how spreads behave under different market conditions. These sessions teach participants how to analyse order book depth, interpret spread changes, and time trades effectively.

For a deeper dive, the book The Systematic Trader v.2 dedicates entire sections to execution techniques aimed at minimising the impact of spreads. It provides clear examples of how various order types interact with bid-ask spreads and offers practical advice for choosing the right approach based on market conditions.

Meanwhile, the Systematic Trading Profits programme takes a hands-on approach. Traders work with historical spread data to identify patterns and opportunities, honing the skills needed to make quick, informed decisions in live markets. This type of practical training is invaluable for mastering trade execution.

Conclusion

The bid-ask spread plays a crucial role in understanding market liquidity and sentiment. For traders in Singapore, grasping this concept can significantly influence trading decisions and profitability.

Focusing on spreads can reshape how you view each trade. A narrow spread during peak trading hours often signals efficient price discovery and strong market activity. On the flip side, wider spreads – common in smaller-cap stocks – can indicate lower liquidity and higher transaction costs. Recognising these patterns allows you to fine-tune your trading strategies.

Beyond individual trades, the bid-ask spread reflects real-time market sentiment and supply-demand dynamics. Market makers, for instance, earn their fees through these spreads, ensuring the market operates smoothly. This continuous adjustment of prices helps reflect new information and shifts in investor behaviour.

To navigate the market effectively, consider strategies like trading highly liquid instruments with tight spreads during active hours. Using limit orders can also help manage costs, especially in volatile conditions. In periods of heightened market swings, patience and caution become even more critical, as spreads can widen dramatically.

Ultimately, the bid-ask spread serves as a transparent indicator of market health and efficiency. Incorporating spread analysis into your trading approach can not only help reduce costs but also offer deeper insights into market dynamics, improving trade timing and profitability.

For traders looking to deepen their knowledge and sharpen their strategies, the Collin Seow Trading Academy offers tailored courses, free webinars, and resources designed specifically for Singapore’s market. Visit Collin Seow Trading Academy to learn more.

FAQs

How does understanding bid-ask spreads enhance trading strategies in Singapore?

Understanding bid-ask spreads plays a key role in refining trading strategies within Singapore’s market. When the spread is narrower, it typically points to higher liquidity and active trading. This often results in more efficient price discovery and reduced transaction costs. On the other hand, wider spreads can indicate lower liquidity or heightened market uncertainty, which may help traders identify potential risks.

Keeping an eye on bid-ask spread changes gives traders valuable insights into market sentiment and helps them time their trades wisely. For example, during high-liquidity periods, tighter spreads can offer better opportunities to enter or exit positions. This understanding empowers traders to manage costs effectively, fine-tune their strategies, and make smarter decisions in Singapore’s fast-moving market environment.

What causes bid-ask spreads to change, and how can I predict these shifts?

Bid-ask spreads are shaped by factors like market liquidity, volatility, and trading volume. When liquidity is tight or market volatility spikes, spreads tend to widen, leading to higher transaction costs. Conversely, when trading volumes increase and markets are stable, spreads usually narrow, making trades smoother and less expensive.

To stay ahead of changes in spreads, monitor key market indicators such as liquidity levels, volatility indices, and trading activity. In Singapore, events like major economic announcements or times of market uncertainty often cause spreads to temporarily widen. Staying updated on these factors can help you better manage trading costs and choose the right moments to execute your trades.

Why are bid-ask spreads crucial for understanding market liquidity and sentiment?

Bid-ask spreads play a key role in understanding market liquidity and investor sentiment. When the spread is narrow, it usually signals higher liquidity, making trades easier and less expensive. On the flip side, a wider spread often points to lower liquidity, increased transaction costs, and possible inefficiencies in the market.

These spreads can also offer clues about shifts in market sentiment. For example, during times of strong investor confidence, spreads tend to tighten, reflecting better liquidity and a more optimistic outlook. In contrast, wider spreads often suggest market uncertainty or a more cautious approach from investors.