What is the maximum bid-ask spread you would consider in basis points ?

28th Sep '15 by Redrichmond

5 comments 6465 reads

Having spent some serious hrs and time creating folios and investing, can anyway advise if there is a limit for the spread (bps)

Stockopedia is a absolutely fantastic tool to slice and analysis the data

I tend to use p/s less than 1 with momentum >80 and the stock rank >90 with a market cap >50 million as well as analysing losts of other key indicators. Keeping it simple (Excluding any foreign markets) . I have approx 115 shares (Obviously I want to reduce more)

Having been burnt by buying rated stocks but with a high bps I dont wont to keep making mistakes, although making mistakes is a costly way of learning. I,m sitting on the high bps shares now till I make some money back

100bps is 1% ( similar to paying a 1 % commision if my understanding is correct)

Fine tuning now, I was thinking of excluding any share with a bps less than 200? Or even 150? The lower the better

So in theory I need to make 2% to break even before I even make money. (If bps is 200)

Does anyone out there have a opinion on bps spread and values set?

Stocks such as PNA 444 bps, IGR 292 bps, FFY 281 bps , BREE 186 bps , all have got good fundamentals and the 3 of the above are rated high 90's in the stock rank but as you can see a highish spread

Cheers
John

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cig

28th Sep '15

Like the price, the trading spread is variable: the more people trade the stock the lower it is and conversely, so just picking lowish current spreads does not guarantee the same when you exit, and conversely, although to a degree they tend to stay within a somewhat predictable range. Besides the displayed spread may be more or less than what you pay when you actually trade as it depends on your broker processes and current market conditions.

The longer your holding period the less it matters, so you can mitigate by having a holding period commensurate with the (predicted) liquidity or trade patiently with limit orders (you then need a broker offering direct market access).

A good way to stay sober with costs is to track your initial portfolio (as if you had never sold anything) in some online tool and see if your actively traded real portfolio beats it.

Edward Croft

Personally I don't like high bid-ask spread stocks. They can be hard to trade, and there's nothing worse than opening your position and seeing a nasty deficit to make up. But that's one of the reasons that illiquid stocks outperform - many take one look at the spread and go no further. That's a shame as some of the strongest performers in the stock market have very wide spreads before their big moves. e.g. International Greetings (IGR) has doubled this year and still has a wide spread.

Indeed many academics like Ibbotson have noted that there is a significant payoff to owning illiquid stocks... if you are willing to own enough of them you can earn a "liquidity premium". Illiquid stocks do outperform (on average), but this premium is only really available to those who have long holding periods and can be extremely patient. Most of us can't.

Personally I set a 250bps (2.5%) spread limit on most of my purchases and short sales. Most of the stocks in my tradable universe qualify for this constraint, but the hard limit keeps me out of attempting some expensive trades. As cig mentions people can trade between the spread and the spread varies... so it's worth being flexible and seeing what a broker can do.

Daniel Rudd

Looking at the stock ranks past performance chart, those ranked 90+ with 350m+ market cap (usually smaller spreads) have returned 55% since inception. While those with 90+ 1m+ market cap (usually larger spreads) have returned 75%.

I wouldn't exclude stocks based on the spread size although I would consider the length of the hold and increasing your stake on days when people want to sell.

Redrichmond

Thanks Cig, Ed and Daniel

I get you on the loss when you have just bought something and you are behind straightway because of a high bps

Thanks Ed for sharing your limit. I will Analyse the data in the graphs to estimate average hold time, I,m learning to be patient which is not easy in these times of volilitity

In fact my some of my virtual portfolio is up some 220% in less than a year (as its not my real money I was taking large risks). I ,m a bit more reserved when it comes to my real cash. Mind over matter

Back to the graphs and studying the data

Thanks
John

Rusty2

29th Sep '15

I'm not keen on wide spreads, who is? However I picked 20 shares in June in a NAPS portfolio and by far and away the best performer, over 40% is Adept Telecom (LON:ADT) with a spread of 747 bps. The worst performer is Lamprell (LON:LAM) (-31%) with 22 bps spread. Think it depends how you invest or trade. Problem with wide spreads is they can get wider if there are problems. Sometimes they do come right down, when there is a lot of trading. I think upto 300 bps is ok, over that I would reconsider whether to invest.

What is the maximum bid-ask spread you would consider in basis points ?

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Redrichmond

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