Proportional Spread

The prices for securities that trade on an exchange are determined by bids and asks. Bids represent the amount potential buyers want to pay. Asks refer to the amounts potential sellers are looking to receive.

You can gather information about the security based on the difference between the bids and asks. Specifically, the wider the spread between the bids and the asks, the less liquid the security is. When there are lots of buyers and sellers out there, the bids and asks are closer together. The market is liquid. It's easy to determine a price.

If there aren't a lot of people out there looking to trade the security, the process gets dicier. You get big spaces between the amounts people want to pay and the amounts people are willing to receive. It gets harder to determine a price. The security is considered illiquid.

The proportional spread provides the mathematical description of this relationship. It represents a measure of liquidity, as described by the bid-ask spread. To calculate the figure, find the difference between the ask and the bid. Then divide that by the average bid/ask price (or half the value of the sum of the bid and the ask). To make that a little clearer, here's the equation:

(Ask - Bid) / ((Ask + Bid) ÷ 2)