The Spread in Low-Liquidity Stocks — Trading Volume Is a Cost
Have you heard that with an unpopular stock, both buying and selling are a loss? The identity of that loss is precisely the "wide spread."
The Spread Is an Immediate Cost
The bid-ask spread is the difference between "the price at which you can buy right now (the ask)" and "the price at which you can sell right now (the bid)."
If the spread is wide, then when you resell a stock immediately after buying it, you take a loss equal to this difference on the spot. For example, if it is $101 when you buy and $99 when you sell, about 2% disappears on a round trip alone. This cost is not printed on any commission, but it genuinely occurs.
Why It Widens When Trading Volume Is Low
The spread depends on how many people are waiting to buy and sell that stock.
An actively traded large-cap has quantity stacked thickly across tightly packed quotes, so the price people want to buy at and the price they want to sell at are almost touching (a narrow spread).
Conversely, a thinly traded small-cap or newly listed stock has thin waiting quantity. From a market maker's standpoint, the risk until they can resell is large, so they widen the spread to be compensated for that risk.
In other words, "low trading volume" is itself a hidden cost. With a low-liquidity asset, you have to accept a wide spread both when entering and, especially, when exiting in a hurry.
Why It Is More Dangerous in a Crisis
The real risk of a low-liquidity stock is revealed when the market plunges.
The spread is wide even in normal times, but in a crisis when everyone rushes to sell, the waiting buy quantity thins out further and the spread widens explosively. The situation of "not being able to sell at a fair price," that is, liquidity risk, becomes real.
So it is safer not to put money you may urgently need into low-liquidity assets. A wide spread looks like a small cost when things are calm, but it bites hardest exactly when you need to sell.
常见问题
Q. How do I know in advance whether the spread is wide?
Look at the difference between the top buy quote and the top sell quote in the order book. If that difference is large relative to the price, or if the daily trading volume or value is very small, the spread is likely wide. The habit of checking before you rush in with a market order helps.
Q. How do I reduce the spread cost?
Pinning down the price you want with a limit order, and filling slowly in pieces rather than all at once, helps. Above all, the best saving is not to buy and sell low-liquidity stocks often in the first place.
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