Quick definition Bid-ask bounce is the tendency for prices to revert toward the midpoint after moving away. When a trade occurs at the ask (above midpoint), the next trade is more likely to be at the bid (below midpoint). What it is Every trade occurs at either the bid or the ask. A buy order hits the ask; a sell order hits the bid. This creates a mechanical pattern: - Buy at 100.51 (the ask) - Next trade: sell at 100.50 (the bid) - Next trade: buy at 100.51 (the ask) Prices bounce between bid and ask due to the alternating direction of trades. Why it matters Bid-ask bounce affects trading costs and performance measurement. A trader buying and immediately selling can lock in a loss equal to the spread, even if no fundamental information changed. Bid-ask bounce is also important for performance attribution. It can appear that a price has moved when actually it has just bounced. Bid-ask bounce versus efficient pricing Bid-ask bounce is mechanical and unrelated to price discovery. It is not an inefficiency; it is a consequence of the discrete bid-ask structure. Practical example The bid is 100.50 and ask is 100.51. A series of trades: 1. Market buy: execute at ask 100.51 2. Market sell: execute at bid 100.50 3. Market buy: execute at ask 100.51 4. Market sell: execute at bid 100.50 The price alternates between 100.50 and 100.51. The true fundamental value might be 100.505, but you only see 100.50 and 100.51. Volatility measurement Bid-ask bounce inflates measured volatility. A stock that trades only between bid and ask experiences zero fundamental volatility but positive measured volatility. Researchers use bid-ask bounce-adjusted volatility for accurate analysis. See also - Bid-Ask Spread - Mean Reversion - Realized Spread - Effective Spread
