What does "spread" refer to in trading?

In trading, "spread" specifically refers to the difference between the bid and ask prices of a security. The bid price is the highest price that a buyer is willing to pay for a security, while the ask price is the lowest price that a seller is willing to accept. The spread serves as an important indicator of market liquidity; narrower spreads typically indicate a more liquid market where transactions can occur more easily, while wider spreads may suggest less liquidity and greater uncertainty.

This understanding is crucial for traders because it impacts transaction costs. When trading a security, a trader typically buys at the ask price and sells at the bid price, so the spread represents a cost to the trader that must be considered in profit calculations. Recognizing how spreads function in various markets can inform trading strategies and help traders make more informed decisions.