Gladly, we have come to another season of crypto academy and I will like to appreciate the effort of the steemit team for their continuous support towards members of the steemit community. I attended the lecture given by professor @awesononso this week and I must confess that I enjoyed every bit of the class. The professor gave out a detailed explanation on the topic and after understanding the topic, I couldn’t wait any longer than to dive straight into the assignment.
Without wasting time further, I will head straight to answer the questions asked by the professor on this week’s task.
Question 1- Properly explain the Bid-Ask Spread.
I will like to describe this concept with a traditional market setting: There are basically two categories of people in market, the first category are the sellers while the second category are the buyers. Usually, before going to the market you will have a list of the items you want to purchase and the amount you think the commodity should go for. When you get to the market, the seller will present you with the ‘’ask price’’ which is the price that he wants to sell the available commodity.
On the other hand, you as the buyer has in mind the amount you want to purchase the commodity and this price is known as the ‘’bid price’’.
The difference in the price range of these sellers could be described as ‘’Bid-Ask spread’’. The closeness or difference in the bid-ask spread will determine if the transaction of buying and selling will hold or not.
Now taking it to the world of cryptocurrency, in order for the validity of a token to be maintained, there has to be a constant process of exchange. In order for exchange to take place, there has to be a ask price and a bid price. Now that we understand what a ask price and bid price is in a traditional market, it will be easier for us to relate it in the cryptocurrency space.
Describing Bid price and Ask price in the crypto space.
Bid price is the highest amount a buyer is willing to pay for a certain commodity at a given period. On the other hand, ask price is the minimum price the seller is willing to give out its commodity at a given period.
Bid-Ask Spread.
The Bid-Ask spread can be described as the difference shown between the bid price and the ask price. For example, if the bid price of a token is $50 and the ask price is $60, the difference between the bid and ask price is $10. In this case, the Bid-Ask Spread is $10.
Looking at this graph for example, we will have to subtract the Bid price from the Ask price and in this case we have: $100,600- $100,400 = $200. The Bid-Ask spread in this case is $200.
Question 2: Why is the Bid-Ask Spread important in a market?
Either in a traditional or virtual market, sellers and buyers need to come to a point of conducting transactions. Bid-Ask spread clearly displays the reaction of the market to a certain commodity at a given time.
Based on economic logic, demand and supply is always an outcome of buyers and sellers reaction. When there is an equivalent amount of willing buyers and sellers in a market, it becomes really easy for trade to get executed and at this point, the market is considered a liquid one. In a liquid market, the bid-ask price will be small since the bid price will be significantly close to the ask price.
This simply means that whenever we notice a small spread, it signifies a liquid market and we can expect a high trading volume. However, if we discover a large spread it signifies that expected trading volume will be lower. Bid-Ask spread helps traders to identify the liquidity of a market, the appropriate time to enter or exit the market and what trade strategy should be applied.
Question 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 percentage.
Using the formula: Spread= Ask price- Bid price.
(a) In this case: Bid price is $5
Ask price is $5.20
Bid-Ask spread= Ask price- Bid price.
$5.20- $5 = $0.2
(b) Using the formula: %Spread= (Spread/Ask price) X 100
= (0.2/5.20) X 100
= 0.0384 X 100
=3.84%
Question 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.
Using the formula: Spread=Ask price-Bid price.
(a) In this case: Bid price is $8.40
Ask price is $8.80
Bid-Ask spread =Ask price-Bid price.
$8.80-$8.40 =$0.4
(b) Using the formula: %Spread= (Spread/Ask price) X 100
(0.4/8.80) X 100
= 0.0454 X 100
= 4.54%
Question 5: In one statement, which of the assets above has the higher liquidity and why?
The liquidity of an asset can be identified from the value gotten from the spread.
Therefore, we must consider Spread of crypto X which is $0.2.
Then Spread of crypto Y which is $0.4.
We have discussed that liquidity is higher with a lower spread, the bid price and ask price of Crypto X is closer to one another than Crypto Y, this establishes the fact that Crypto X has a higher liquidity.
Question 6: Explain Spillage.
At the beginning of this post, I tried to explain the idea of buy price and ask price in a traditional market. After a traditional negotiation, the buyer and seller might have to agree on a price that is not initially intended. At this point, we consider that the process of spillage has occurred.
Spillage in crypto market occurs when trade occurs at a different price set by the trader. As a result of the extremely volatile nature of the crypto market, it is inevitable for us to experience price change regularly. There might be a change from the brief time of price set to the time of trade execution which will most certainly affect the price of execution eventually.
We can simply describe spillage as the difference existing between the set price of a trade and the executed price.
Question 7: Explain positive spillage and negative spillage with price illustrations for each.
Trading is usually in two sides, there is always a buyer and a seller. With the possible occurrence of spillage during trading, it is possible for the trade to either favour the buying side or the selling side.
Positive Spillage.
A positive spillage occurs when an order is filled at a suitable position for the trader. If a buy order is filled at a point lower than the actual set price, then a positive spillage has occurred. At this point, the trader will be able to purchase the asset at a price lower than he intended, on the other hand, if a sell order is filled at a position higher than the set price, it also means that a positive spillage has been created and the trader will be able to sell the asset at a price that is higher than the intended amount.
Illustration with price.
A trader placed a buy order for token A at $60, if this order was however executed at $55, the positive spillage will be:
$60-$55 =$5.
If on the other hand, a trader places a sell order at $30 and the order was executed at $34, the positive spillage will be:
$34-$30 =$4.
Negative Spillage.
Negative spillage occurs at a price that puts the trader at loss because the result does not benefit the trader. For a buy order, the trade is actualized at a price higher than the price placed by the trader. On the other hand, a sell order is filled at a price that is lower than the set price.
Illustration with price.
If a buy order is set by a trader at $4 and the order got filled at $4.5, negative spillage order is:
$4.5-$4 = $0.5
If on the other hand, a sell order is placed at $3.5 and the order got filled at$3, the negative spillage order is: $3.5-$3.45=$0.05
Conclusion.
I am excited to have attended the lecture by professor @awesononso, I have really learnt so much from this class and assignment. This topic is important for every trader and basically anyone in the crypto space.