What is the relevance of a touchline with the bid-ask spread?
Let us start with the bid-ask spread.
Let us start with defining a bid-ask spread. It is the difference that we get between the bid and ask price. The bid price is the highest amount that a buyer can pay for an asset, while the ask price is the least amount that a seller can accept for the asset he is selling. The bid-ask spread will tell us a lot about the liquidity of a market. A tight spread means enough liquidity, while a widespread implies that the market is not liquid enough. We are saying this because the bid-ask spread is very relative to our main topic today: the touchline.
What is a touchline?
A touchline refers to the best bid price or ask price for a specific security at a given time frame. Hence, it is the highest price a security buyer is ready to bid and the lowest price a seller can offer or sell during a trading day. So, if we think about it, the spread that stands as the touchline is also the bid-ask spread of a security. As we mentioned earlier, a tight spread signifies enough liquidity, while a wide one means that there is not enough.
Let us cite a scenario.
To take our explanation further, let us cite a scenario. Let us say that a security has multiple buyers with different bids. If the bids are $10, $10.2, and $10.4, which among the three is the touchline? It will be the highest one which is $10.4.
Let us now hop in the sellers’ perspective. Let us say that multiple sellers offer the similar security. Their offers are at $10.6, $10.7, and $10.9. Which among the three is the touchline? It will be the lowest offer which is $10.6.
In this case, this security has a $10.4 bid and a $10.6 ask. The spread or the difference between the two is $0.2.
Bid-ask spread and the touchline
We can get a good idea about a particular asset’s supply and demand through the bid-ask spread. The bids are the ones that stand as the demand while the asks are for the supply. Both of their depths make a significant impact on the spread. In fact, if one is considerably more than the other or if both of them are not sturdy enough, the spread would widen.
Traders should be aware of those who take advantage of the spread. They can be brokers, market makers, and even fellow traders. Some widen the spread so they can earn more profit. Let us say that Mr. A makes a bid at $10.50, and Mr. B sells the security at the stated price. Later on, Mr. A sells the security to another person at $11.0. Mr. C agrees to buy the security at $11.0. Now, Mr. A generates a $0.50 profit for every share that he trades. Some can and will widen this spread, and some naïve traders will agree and buy an expensive stock share.
Closing with a quick summary
Touchline is the highest price a buyer is ready to bid on and the lowest price a seller is prepared to offer. The touchline bid is the highest bid, and the touchline is the lowest offer. Their difference is the spread. The bid and ask price are not stagnant. Anyone can instantly buy from the offer, and the share posted at that price gets eliminated.