If you have ever traded securities, such as forex pairs, stocks, or crypto, you have probably noticed two different prices for a particular instrument - the bid and the ask. Bid and ask prices are central to the price discovery process, as the mechanisms by which the market determines the fair value of an asset. If we look at the bid and ask prices explained for complete beginners, the bid is the price a buyer is willing to pay for an asset, while the ask is the price a seller is willing to accept. In a market with millions of participants, the price describes the aggregate knowledge, expectations and information about the asset, which is constantly being updated by buying and selling activity. The process of price discovery using bid and ask prices helps reduce the potential for manipulation. The difference between the bid and ask prices is called a spread, which represents the slippage between the buying and selling prices. When the spread is tight, participants get a more stable price that is not easy to skew, and vice versa. Market Liquidity and Efficient Trading The bid and ask prices enable liquidity in the market by facilitating the matching of buyers and sellers. For a transaction to take place, there needs to be a buyer who is willing to pay the ask price and a seller that is willing to sell at the bid price. In highly liquid markets, these prices are usually very close, which means that transactions can happen quickly and efficiently. On the other hand, in illiquid markets, the bid-ask spread tends to be wider, which makes it more difficult to execute trades without a significant impact on the transaction price. Market makers, such as brokerage firms and automated trading systems, often play a crucial role in providing liquidity by noting both bid and ask prices. They facilitate trades by being ready to buy at the bid price and sell at the ask price, while they profit from the difference between the bid and ask price, or the spread. Bid and ask in different markets An important feature of bid and ask prices to note is the universal way of how they work in different markets. Whether traders are buying and selling stocks, forex, commodities or crypto, the definitions of bid and ask prices remain constant. However, liquidity tends to fluctuate considerably between different asset classes, which means the spreads may be higher on certain stocks, as opposed to major currency pairs, such as the EUR/USD. Arbitrage Arbitrage is common on markets that are characterized by inefficiencies and major discrepancies between the bid and ask prices. Therefore, a trading strategy that exploits these inefficiencies is called bid and ask arbitrage, which entails traders buying at a lower bid price and selling at a higher ask price. This has been particularly popular on the crypto market, as the early days of the crypto industry saw considerable bid and ask differences between different exchanges. Arbitrage opportunities arise when there is a discrepancy between the bid and ask prices between two or more markets or exchanges. For example, let’s consider two different exchanges providing different bid and ask prices: Exchange A:

• Bid Price - $100
• Ask Price - $101

Exchange B:

• Bid Price - $99
• Ask Price - $100

In this scenario, a trader can engage in arbitrage by:

• Buying an instrument on Exchange B at the ask price of $100
• Selling the instrument on Exchange A at the bid price of $101

The $1 difference between the two prices represents the arbitrage profit generated by the trader, assuming there are no commissions or other trading fees. Traders can engage in different types of arbitrage - Cross-market, cross-asset and triangular arbitrage on the forex market, which arises from price discrepancies between three currencies.

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