When you hear someone speaking about the investing in the stock market and you hear words like spread or bid, you might be a little confused. Youre not sure what they mean exactly or how they work in the market. These terms are key tools you can apply to your investment strategy and they are instrumental in how effective your sale or purchase of a stock will be in earning profits. Even if you only want to invest a few dollars here and there and are not really looking to become a major player in the market, it would be well worth your while to learn these terms.

The Basic Theory

One of the most basic concepts of economics and the fundamental idea on which our entire economy is based on is the law of supply and demand. Before you can understand the intricate terms of the market, you need to understand the basic economic truth. Supply is the sum total of any given item presently available in the marketplace and demand refers to how much money any one person is willing to pay for it. Investopedia explains the importance of the relationship that exists between these two,

The relationship between demand and supply underlie the forces behind the allocation of resources. In market economy theories, demand and supply theory will allocate resources in the most efficient way possible.

In order for any of us to become successful investors and traders, we need to fully understand this concept and how it affects the stock market.

The spread represents a difference between a bid and an asking price for any particular stock. The laws of supply and demand usually determine this spread; the more the public is willing to pay for a certain stock, the more supply there will be available. Understanding this spread can help you to find a buyer or seller at your particular price. Usually, this is done with a specialist in the particular stock you are looking to trade.

You can learn a lot from analyzing the bid ask spread and how it changes over time. Many investors, analysts and specialists watch these figures and trends carefully to help them to predict what the stock will do in the future. Michael Sincere, Investment Analysts explain ,

Although the spread wont help you pick the right stock or choose the best entry or exit price, it can help you to determine short-term trends. For example, you can see whether the spread is leaning towards buyers or sellers. If you see that people are buying on the ask price, then momentum might be developing.

It is also true that if you have noticed that people are selling at the bid price then it could be an indication that the stock in question is ready to start to lose value.

How Can You Use the Spread to Your Advantage?

Other things you can watch for is when the bid/ask spread suddenly begins to widen. This could be an indication that the stock is about to change direction. If the stock has been on a steady climb and suddenly the spread rises, then it may be wise to start selling if you are into day trading; it may be just about to reverse direction. On the other hand, if the stock has been trending downward throughout the day but the spread widens, it may be just about ready to turn to a more positive direction.

Basically, a strong demand for product will come before a rise in stock prices while a weaker demand will mean a lower price. The concept seems very basic and straightforward; however, for the newcomer it may be just a bit confusing. It is crucial that you learn to observe the bid/ask spread to determine what is happening when you do see the changes appearing in this figure.

Dont be fooled by the penny stock increments and thinking that a few pennies doesnt make a difference because it does! When a stock gets around 5 dollars or less, these spreads start to really mean something, so please be careful and always use limit orders.

The whole concept could cost you a great deal of money if youre not careful. For most people, taking the time to watch the market prices change every few seconds could be frustrating and unproductive. You need to know exactly what you plan to do in any given situation before you start to invest. Having an exit strategy in place for different eventualities can help to save a lot of money.

The Limit Order

Knowing ahead of time what to do when the market begins to turn downward can help you to get out of the market before the price dips too low. Having a limit order is one surefire way to guarantee that you sell off your shares in time enough to keep you from losing your shirt when things start to go south.

Determine the price that you expect to sell at even before you buy the stock. This way your broker will know clearly just when to sell your stock. Timing is a key element here, however. Be realistic though, when a stock begins to fall, many people will be looking to sell off their shares; so dont expect that the stocks will sell right away. For this reason, you must set your limit order well enough in advance that you dont lose even more money while youre waiting to sell. And there may be times when you cant sell your order at all. When that happens, be prepared to move your limit price or youll probably end up being stuck with some poor performing stock and youll be losing money for every day you own it.

Selling stocks can be risky business if you are not aware of the strategies that the professionals use in making their investments. The more knowledge you have about different strategies and types of investments, the more protection you will have; this way you can make sure that youre prepared for just about everything they can throw at you.