Why do bid/ask Spreads Tighten/Widen ?

Discussion in 'Trading' started by In2Deep, Mar 3, 2011.

  1. In2Deep


    Sometimes while watching price action on a chart I will see the bid/ask spread jump from one penny to something like 10 points. Sometimes it does the opposite.

    Why does this happen? What kind of market conditions or order flow cause the exchanges to do this?

    It seems to happen less on very high volume instruments like INTC or MSFT.
  2. Best I can recommend is read Chapter 14 ("Bid/Ask Spreads") of "Trading & Exchanges (Market Microstructure for Practitioners)" by Larry Harris.

    At a very superficial level, understand that what you likely see as bid/offer spread is BBO ("Best Bid and Offer"), i.e. the tightest spread available at that time across all particpants bidding/offering.

    And with the BBO, it is almost certain that the market participant whose bid currently sets the "Bid" will be different from the market participant whose offer currently sets the "Offer" ... and what these particpants bid or offer changes all the time as they manage their inventory or speculate ... it's this activity that you are seeing, and so spreads will fluctuate.

    And in more liquid instruments, with more participants, if one participant removes their bid/offer (or is filled at that level), there is more likely to be another participant still offering at the same level (or close to it), so spreads will fluctuate less.
  3. high volume = small spread
    low volume = big spread