Remember the bid-ask spread when trading stocks
If you look at the quoted price for any given stock, you will see that there are in fact two prices. The first is the bid price - how much traders are offering to buy that stock - and the second is the ask price, which is how much traders are offering to sell it for. In most cases, particularly with high-volume stocks in the US, the difference between these - the spread - is usually just one cent.
However, in some cases, the spread can become wider, and this is something that traders need to pay attention to. Especially if they are trading on a short term basis.
What affects the spread?
One factor that can affect the spread is the price of the stock. For example, the spread on a $50 stock is often higher than the spread on a $5 one. While this may seem intuitive - in other words, the spread stays as some fixed percentage of the overall stock price - the reasons for this are actually a bit more complicated. The stock price - and percentage spread - does play a role, but volumes are also a factor. In other words, because the stock price is higher, fewer stocks change hands, leading to a sparser order book and more gaps between bid and ask prices.
In general, volume affects all stocks in this way - not just high-value ones. Stocks with low volumes tend to develop more gaps in the order book, leaving certain price levels with no buyers or sellers. This obviously increases the spread.
Volatility is also something that can affect stock spreads. In other words, if a stock is rising or falling quickly, then the gap between what traders are willing to pay now and the last transaction price grows as well. All of the buying and selling interest becomes more loosely scattered because of this, leading to wider spreads.
Why are spreads important?
For many high-frequency day traders, their entire strategy is built around scalping the market - taking advantage of the spread. On the one hand, a bigger spread can result in more profits for each trade, but it also increases risk. This is because it makes it more difficult for traders to exit their positions - in fact, large spreads in periods of high volatility can lead to a phenomenon known as slippage, where day traders do not receive the price that they expect.
This is a problem overall, but can be a particular problem when they place stop orders to limit risk - traders can end up losing more than they had anticipated when they set up the trade.
However, all traders - not just day traders - should pay attention to spreads. First of all, a high spread is a tax on every trade, since traders need to make back the spread before they are in profit. Also, a very high spread can indicate that there are liquidity problems with the stock - making it very difficult to exit at a particular price.
While this may not be so much of an issue for long-term value investors, it definitely is a problem for mid/short-term investors who are looking to trade on trends and reversals. For example, some small penny stocks have spreads that are as high as 20%. Meaning you'd have to make a 20% return just to break even.