If you were to peek over a professional trader's shoulder to look at their computer screen, you'd see a line with numbers above and below the line. These are buy and sell offers. When the trader gets a message from a client, he or she has to look at all those numbers and find the "best bid" or best price for that client.
Example:
A client wants to buy a million shares of GOOG on a "best execution" basis. The trader looks at the offers to sell GOOG, which are all over the place: $582.34, $582.12, $582.23, etc. He is obligated to take the best price for his client (the cheapest price). But sometimes the cheapest price is only good for 100 shares. In that case, the trader takes the smaller chunks in pieces, starting from best bid, until he can fulfill the million-share order.
Related or Semi-related Video
Finance: What is Spread?48 Views
finance a la shmoop. what is spread? before we start just no. get your mind
out of the gutter. spread refers to the money value between [100 dollar bill]
a bid and ask price under a market maker structure of trading securities. no more
wire hangers, a plastic hanger company is publicly traded on an exchange like
Nasdaq where buyers bid for a price to purchase and sellers ask for a price to [Nasdaq wall shown]
trade. no more wire hangers is bid this moment at 37:23 a share by buyers
willing to buy right now at that price and is being asked at this moment at a
price of 37.31. note the eight cents a shared difference in the share prices.
that dif is the spread between the two prices, and it's worth noting that in [bread is buttered]
extremely volatile stocks, the spread widens. and in boring highly liquid
stocks which don't move much, the spread tightens or is narrower. that is on a
volatile equivalent of no more wire hangers the spread might grow to 20 or
30 cents a share whereas a boring name that pays a big dividend and the stock
never moves much we're thinking AT&T here, [man snores at a desk]
well that spread might be just three or four cents. so why grow? well because a
market maker in a volatile stock doesn't want to be caught losing money on her
inventory. if no more wire hangers suddenly gapped down to 37.10 a share [equation shown]
well it would be likely less than the average of what the market maker paid
for her quote "inventory" unquote in that stock from which he was making a market
in it. each time the shares trade the market makers dip into that spread to [woman dips cracker in butter]
pay their bills and allow them to keep doing business. so that's spread. and it's
not the type that Prince used to sing about. [man on stage]
Up Next
What is Best Execution? One of the ways in which brokers can make money on trades apart from charging commissions is in getting a portion of the bi...