What does a narrow bid-ask spread in a market signify?

A narrow bid-ask spread significantly indicates higher liquidity in the market. Liquidity refers to the ease with which an asset can be bought or sold in the market without causing a significant impact on its price. When the bid-ask spread is narrow, it shows that there is a smaller difference between the price buyers are willing to pay (the bid) and the price sellers are asking for (the ask).

This closeness in the prices typically reflects a high level of trading activity, implying that many participants are actively buying and selling the asset. As more participants enter the market, both the number of trades and the volume of transactions increase, which generally leads to quicker execution of trades and a more efficient price discovery process. In contrast, a wider bid-ask spread suggests lower liquidity, where fewer trades occur, thus resulting in higher costs to buy or sell the asset.

The other options present scenarios that do not directly relate to the implications of a narrow bid-ask spread. For example, a narrow spread does not indicate lower trading volume; in fact, it often correlates with higher trading volume. Additionally, a narrow bid-ask spread is associated with market stability rather than increased instability, since reduced price fluctuation tends to happen when liquidity is higher