The Bid-Ask Spread - The Price of Liquidity

I'm Andy Temte and welcome to Money Lessons! Join me every Saturday morning for bite-sized lessons that are designed to improve financial literacy around the world. Today is March 14th, 2026.

Last week, we wrapped up our fourteen-episode journey through the world of debt securities. This week, we're turning our attention back to stocks. Between October and November of last year, we traced the history of equity ownership from Roman publicani through the Dutch East India Company all the way to smartphone investing. We covered two thousand years of history—but we never got into the mechanics. How do stock prices get determined? What happens when you tap "buy" on your phone? Today, we start answering those questions—and the key to understanding all of it is one word: liquidity.

The Buttonwood Agreement

On May 17, 1792, twenty-four stockbrokers gathered beneath a buttonwood tree—what we'd call a sycamore today—on Wall Street in lower Manhattan. They signed a simple two-sentence agreement: they would trade securities only with each other and charge a fixed minimum commission. No building, no trading floor, no regulations—just a handshake deal under a tree. But that agreement created something invaluable. By concentrating buyers and sellers in one trusted group, those twenty-four brokers made it dramatically easier to trade. They created liquidity—and that changed everything.

It's another example of the pattern we've seen throughout this series—informal gatherings evolving into formal institutions, just like Jonathan's Coffee House becoming the London Stock Exchange.

The Liquidity Problem

So what exactly is liquidity? Liquidity is the ease with which you can buy or sell an asset without significantly affecting its price. A liquid market means you can trade quickly at a fair price. An illiquid market means you might wait days for a buyer—or accept a steep discount just to get a deal done.

Before organized exchanges, finding a buyer for your shares was like trying to sell a used car without the internet. You had to know someone, negotiate privately, and hope you weren't being taken advantage of. The Buttonwood Agreement created a central meeting place where buyers and sellers could find each other reliably.

Here's what makes liquidity so important: without it, ownership becomes a trap. You might own shares in a wonderful company, but if you can't sell those shares when you need cash, your ownership isn't worth nearly as much as you think. Liquidity is what makes the difference between owning an asset and owning a useful asset. It's the reason the Dutch East India Company's transferable shares were so revolutionary back in 1602, and it's the reason modern stock exchanges exist today.

But as trading volume grew through the 1800s, even a centralized exchange wasn't enough. Too many buyers chasing too few sellers—or vice versa—caused wild price swings. The market needed someone to step in and keep things orderly.

The Rise of the Specialist

In the 1870s, after the NYSE merged with the Open Board of Brokers and adopted continuous trading, a new role emerged: the specialist. Each specialist was assigned to specific stocks and stood at a designated post with one obligation—maintain a fair and orderly market. If buyers showed up but no sellers were available, the specialist sold from their own inventory. If sellers appeared but no buyers were ready, the specialist bought. They were human shock absorbers, providing liquidity when the market couldn't provide it on its own.

The role was extraordinarily lucrative. Each specialist had exclusive access to the "book"—the record of all pending orders for their assigned stocks. That informational advantage made specialist firms among the most profitable on Wall Street. At their peak, a seat on the NYSE—required to operate as a specialist—sold for as much as $4 million.

Specialists evolved into what we now call designated market makers, or DMMs. The role has gone largely electronic, but the principle hasn't changed: someone must always stand ready to buy and sell so that investors can trade whenever they want. Every time you sell a stock within seconds, you're benefiting from the liquidity that market makers provide.

The Bid, the Ask, and the Spread

Here's something that surprises most new investors: at any given moment, a stock doesn't have one price—it has two. The bid is the highest price a buyer is currently willing to pay. The ask—also called the offer—is the lowest price a seller is currently willing to accept. The difference between them is the bid-ask spread.

Let's say you're looking at shares of a large company. The bid might be $150.00 and the ask $150.02. That two-cent gap is the spread. If you want to buy immediately, you'll pay the ask—$150.02. If you want to sell immediately, you'll receive the bid—$150.00. The spread is, in effect, the price of liquidity. It's the cost you pay for the convenience of trading right now rather than waiting for a better match.

For heavily traded stocks—think of the biggest companies you know—the spread is typically just a penny or two. But for smaller, less liquid stocks, spreads can be much wider. That wider spread is the market telling you something: fewer people are trading this stock, so the cost of instant liquidity is higher.

Pieces of Eight and the Hidden History of the Spread

Here's where the history gets fun. For over two hundred years, stock prices in the United States were quoted in fractions—not decimals. If you bought stock in the 1980s, you might have seen a price like $14⅛ or $23⅜. Why eighths? The answer traces back to pirate treasure—or more precisely, to the Spanish silver dollar.

In colonial America, there wasn't enough British currency to go around. The coin that filled the gap was the Spanish silver dollar, worth eight reales—reales being the basic unit of Spanish currency at the time. People literally cut these coins into eight pie-shaped pieces to make change—the famous "pieces of eight" from pirate lore. When you hear someone say "two bits" for a quarter, that's two-eighths of a Spanish dollar, or twenty-five cents. The expression has survived for over two hundred years.

When the New York Stock Exchange began trading in the 1790s, the Spanish dollar was still the dominant currency in circulation. So stock prices were naturally quoted in eighths of a dollar, making the smallest possible spread 12.5 cents per share. That convention stuck for over two centuries. By the late twentieth century, pricing had tightened to sixteenths—6.25 cents—but the fractional system persisted.

Then in 2001, the SEC mandated decimal pricing—dollars and cents. The minimum spread shrank from 6.25 cents to just one penny, saving investors enormous sums annually in trading costs and fundamentally transforming the economics of market making. It also made stock prices a lot easier to understand—no more mental math converting fractions to decimals.

What This Means for You

Every concept we've covered today connects back to liquidity. The Buttonwood Agreement created it. Specialists maintained it. The bid-ask spread is the price you pay for it. And decimalization reduced that price dramatically.

Understanding this gives you a practical edge. When you see a tight spread on a stock—a penny or two—you're looking at a liquid market where trading is cheap. When you see a wide spread—twenty or thirty cents—that's a warning sign. You're paying more for every trade, and you may have trouble selling quickly if you need to. Liquidity isn't just an abstract concept. It's money in your pocket—or money out of it.

Next week, we'll explore the mechanics of placing a trade—the different order types available to you and what happens between the moment you tap "buy" and the moment you own shares.

Until next week... Grace. Dignity. Compassion.