Every quoted stock shows two prices: one at which a buyer can sell immediately and a higher one at which a seller can buy. The gap is the cost of demanding immediacy.
The spread pays for providing immediacy
A market maker commits to buying and selling continuously, which means a trader can transact without waiting for a natural counterparty to appear.
That service has a cost, since the market maker must hold inventory and carry the risk that its value moves before the position is offset.
The spread is the compensation for supplying that service, earned across many transactions rather than on any single one.
Adverse selection is the larger risk
Some counterparties trade because they know something. A market maker cannot distinguish them from uninformed traders at the moment of execution.
Consistently buying from sellers who know the price is about to fall is a losing position, and it must be funded from the profits on ordinary flow.
Wider spreads on less-followed stocks reflect exactly this: less public information means a higher probability that any given order is informed.
Liquidity and volatility set the width
Heavily traded shares can be offset quickly, so inventory is held briefly and the risk of an adverse move during that period is small.
Thinly traded shares may take hours or days to offset, and the market maker prices the intervening risk into a wider quote.
Spreads also widen during volatile periods and around scheduled announcements, when the probability of a large move between trades rises sharply.
Depth matters as much as the quoted spread
A quote applies only up to the size posted at that price, and larger orders reach further into the book at progressively worse levels.
The realised cost of a large trade therefore exceeds the visible spread, which is why institutions break orders into smaller pieces over time.
Displayed depth is also incomplete, since a portion of resting interest sits in venues that do not publish it before execution.
Payment for order flow routes retail trades away from exchanges
Retail brokers often sell their order flow to wholesalers who execute it internally rather than sending it to a public exchange.
Wholesalers pay for that flow because retail orders are unlikely to be informed, making them profitable to trade against at a narrow spread.
Customers frequently receive a price slightly better than the public quote, while the arrangement's effect on overall market quality remains contested among regulators.