Steemit Crypto Academy [Beginners' Level] | Season 4 Week 1 | The Bid-Ask Spread

Welcome everyone to the 4th Season of the Steemit Crypto Academy. Every season, the academy evolves to meet the needs of the community.This season is no different. The goal in the end is to impact as much as possible and make the experience better for the whole community.

I am excited starting this season and I hope you all are too. This week, I will be handling the topic The Bid-Ask Spread. We will get to understand some simple concepts before getting into some very simple calculations. I hope you learn something new.

The Bid-Ask Spread

In a market, there is normally a Bid price and an Ask price. The Bid price of a commodity is the highest price that a buyer is willing to pay for that commodity while the ask price is the lowest price that a seller is willing to sell the commodity for. The Bid-Ask Spread is just the difference between those two prices.

To write is out clearly, the Bid-Ask Spread is the difference between the Bid and the Ask price of a commodity.
Mathematically;

Bid-Ask Spread = Ask price - Bid price

It is also simply called The Spread. This Spread is important and is used widely in markets to determine liquidity.

What is Liquidity?

The forces of demand and supply are always in play in any market. The supply of a commodity is how available the commodity is in a market at a given time. The demand of a commodity is the willingness of people to purchase that commodity at a particular price during a given period of time. A proper balance between these two forces would mean that trades would be executed quickly and so the market would be liquid.

Liquidity, in simple terms, is how easy commodities or assets can be traded. A liquid market is one where there are enough sellers and buyers and trades get executed easily. It is one where the buyers readily want to buy what the sellers are seling. Considering this, it would mean that the bid price would be close to the ask price and so the difference (the bid-ask spread) would be small.

So basically, a small spread means the market is liquid and so we expect that the trading volume to be high as well. On the other hand, a larger spread means the market is illiquid and so the trading volume would be significantly smaller.

Bid-Ask Spread in Cryptocurrencies

The Bid-Ask spread concept is frequently used in the crypto market. Market makers exist in any market and on exchanges, they initiate Limit Orders. These market makers define the price they want to buy or sell an asset with these limit orders. A market maker that places a limit order to buy a coin gives the bid price for that trade. Conversely, a market maker that places a limit order to sell a coin gives the ask price of that trade. The difference between the these Limit orders is the spread.

Below is the Spread for BTC/BUSD;

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_{Screenshot from Binance}

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From the image, the Bid side is the green wave while the Ask side is the Red wave. We can see that the gap between them is very small. That gap is the Bid-Ask Spread.

This means that for BTC/BUSD, there are a good number of Limit orders from both buyers and sellers and so more bid and ask prices. This causes a high trading volume and so a very liquid market.

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Below is the Spread for BTT/TRX;

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_{Screenshot from Binance}

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From the image, we can see that the gap between the Bid side and the Ask side is somewhat wide. This is what a wider Spread looks like. This means that there are fewer Limit Orders initiated by buyers and/or sellers and so less bid and/or ask prices. This market would not be as liquid as the BTC/BUSD market.

Calculating the Bid-Ask Spread

To recap, the formula for calculating the Spread is;

Spread = Ask price - Bid price

The Spread can also be expressed in percentage as follows;

%Spread = (Spread/Ask Price) x 100

That said, let us take an example.

Example:

If the Bid price of crypto A is $50 and the ask price is $50.5, a)what would be the Bid-Ask spread? b)Calculate the Spread in percentage.

Solution:
a) The Bid Price = $50
The Ask Price = $50.5
Bid-Ask Spread = Ask price - Bid price
= $50.5 - $50 = $0.5.

b) %Spread = (Spread/Ask price) x 100
= (0.5/50.5) x 100
= 0.0099 x 100
= 0.99%.

Slippage

There is A type of order called a market order where the trader agreees to a trade at an existing price. Even in this type of trade, there is a small window of time between when the order is placed and when it is executed. Anything can happen within this time especially in Crypto Markets.

Cryptocurrencies are highly volatile assets that can undergo major price changes in seconds. This volaitility can cause prices to change between the time a market order is initiated and when it is executed. The order will then be filled at a price different from what the trader intended. This phenomenon is called a Slippage.

Simply, a Slippage happens when an order is executed at a price different from what was intended. Slippages occur more in crypto markets with a wide Bid-Ask Spread. This is because these crypto markets have low liquidity and so orders might not always be matched as expected.

The Slippage is given as the difference between the expected price of a trade and the price it is executed.

Types of Slippage

(1) Positive Slippage: A positive slippage is when an order is filled at a more favourable price. For a buy order, a positive slippage occurs when an order is filled at a lower price than intended. For a sell order, a positive slippage occurs when an order is filled at a higher price than intended.

For example, If a trade was place for crypto B to be bought at $140 and instead the trade was executed at $138, the Positive slippage would be;
$140 - $138 = $2.

Also, if a trade was placed for crypto B to be sold at $145 and instead the trade was executed at $146, the Positive slippage would be;
$146 - $145 = $1.

(2) Negative Slippage: A negative slippage is when an order is filled at a less favourable price. For a buy order, a negative slippage occurs when an order is filled at a higher price than intended. For a sell order, a negative slippage occurs when an order is filled at a lower price than intended.

For example, if a trade was placed for crypto C to be bought at $100 and instead the trade was executed at $100.50, the negative slippage would be;
$100.50 - $100 = $0.50

Also, if a trade was placed for crypto C to be sold at $90 and instead the trade was executed at $89.8, the negative slippage would be;
$90 - $89.8 = $0.2.

Conclusion

In this class, we have learnt about the Bid-Ask Spread. The Spread is a very important concept used even in the stock and financial markets. Traders can learn to leverage the spread to make more successful trades in any market.

We have also talked about slippages in this class. Slippages happen all the time. These slippages can be in favor of the trader or otherwise. Learning the relationship between this and the Spread can also help traders avoid some losses and make the most of their assets.

Homework

1. Properly explain the Bid-Ask Spread.

2. Why is the Bid-Ask Spread important in a market?

3. If Crypto X has a bid price of $5 and an ask price of $5.20,
   a.) Calculate the Bid-Ask spread.
   b.) Calculate the Bid-Ask spread in percentage.

4. If Crypto Y has a bid price of $8.40 and an ask price of $8.80,
   a.) Calculate the Bid-Ask spread.
   b.) Calculate the Bid-Ask spread in percentage.

5. In one statement, which of the assets above has the higher liquidity and why?

6. Explain Slippage.

7. Explain Positive Slippage and Negative slippage with price illustrations for each.

Rules/Guidelines

• This Task will run until 11th September 23:59 UTC.
• Your article should be at least 300 words long.
• Please try and understand the topic before performing the task.
• Make sure you post this assignment in the Steemit Crypto Academy Community.
• Use the hashtags #awesononso-s4week1 and #cryptoacademy among your first 5 hashtags and tag me @awesononso.
• Plagiarism and content spinning is not tolerated in the Academy. Repeat offenders will be blacklisted and banned from the academy.
• All outsourced images should be copyright free and properly referenced.
• Only students with a minimum of 200SP and a reputation of 55 are eligible to participate. You should also not be powering down.

My Comment section is open for any questions or suggestions.

Thank you.

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