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Understanding Bid and Ask Prices in Forex Trading

Aximtrade | 2023-04-10 13:06

Sommario：The world of Forex trading is highly intricate and entails a plethora of technical terminologies and complex strategies. Among the fundamental concepts that every trader must comprehend, ‘Bid and Ask’ prices are the two prices that traders encounter while trading a currency pair. Proficiency in comprehending how these terms behave is imperative to making prudent forex trading decisions!

Bid and Ask price in Forex!

‘Bid and Ask’ are common terms used in Forex and financial markets in general. It refers to the price that buyers and sellers in the marketplace are willing to buy and sell at. In other words, bid and ask indicates the price at which a currency pair or another asset can be sold or bought at the current time.

What is the Bid Price in Forex？

The ‘Bid’ price is the price that the trader is willing to pay for the traded asset. For example, if a trader wants to buy a currency pair, then the bid price will be the price he has to pay. The bid price represents the highest price that a trader is willing to pay for the traded asset.

What is the Ask Price in Forex？

The ‘Ask’ price is the price that the trader is willing to receive from selling the traded asset. For instance, if a trader wants to sell a currency pair, then the ask price is the price he will get. The ask price represents the lowest price that a trader is willing to sell the traded asset for.

The Current Price

Understanding the current price is essential to understand the difference between the bid price and the ask price. The current price, also known as the market value, is the actual selling price of an asset on an exchange. It is the last traded price of that asset and is constantly fluctuating. The current price is determined by the market forces of supply and demand. Changes to either supply or demand make the current price rise or fall.

Here’s a complete list of Forex Trading Terms every trader needs to know!

Difference between Bid Price and Ask Price in Forex Trading

Simply put, Bid and Ask prices are the maximum and minimum buying and selling prices of a financial instrument.

The Bid price, also known as a ‘Bid’, refers to the highest price a buyer is willing to pay.
The Ask price, also known as the ‘Ask’, is what the seller will accept as the minimum price.

A bid price is usually higher than the current price of an instrument, while an ask price is usually lower.

Example of a ‘Bid and Ask’ Quote Calculation in Forex Trading

In forex trading, bid and ask prices are both applied to a single currency pair at the same time. Suppose there’s a trader called Paul who intends to purchase a currency pair of USD/JPY for 100,000 Japanese yen. Once he buys the pair, he’ll wait until the bid and ask exchange rate rises up to sell the pair and make a profit. Paul seeks a broker with favorable trading conditions to assist him in doing so.

One might think that the price of buying and selling the USD/JPY pair would be the same. For example, if Paul buys $911 at the asking price of 109.69, he should be able to sell the same amount of yen and receive 100,000 yen in return, right？ No, that is not how the system operates, even though it may appear logical to some.

Instead of identical bid and ask Forex price quotations, the two prices differ from one another. Therefore, if Paul purchases $911 at an asking price of 109.69, that will most likely be the maximum amount he will receive from the trade of 100,000 yen. If Paul decides to sell the dollars and buy yen again, he’ll most likely get less yen back.

For the purposes of this example, let’s say that the bidding price is 109.67. This means that the buyer will give Paul back 99,909 Yen, assuming that the overall exchange rate remains the same at that time. This forex bid and ask rate example illustrates how spreads can impact profitability. While a small spread may not seem significant, it can add up if you trade frequently. Therefore, it’s critical to trade liquid pairs such as major pairs during the most active trading hours, such as London and New York.

What does Buying/Selling a Currency Pair mean？

When we refer to bid and ask prices for a particular currency pair, such as USD/JPY, it means that we are purchasing US dollars using Japanese yen. Typically, traders use the base currency (the second currency in the pair) to buy the first currency in the pair.

To determine a satisfactory price point for both buyers and sellers of these assets, we must consider the bid and ask prices. The bid price represents the highest price that a buyer (usually a broker) is willing to pay for an asset. If the price exceeds beyond this point, it becomes too expensive for the buyer to pay. Brokers aim to purchase assets as cheaply as possible, so they negotiate with the seller to lower the price.

On the other hand, the asking price is the minimum price that a seller is willing to receive for an asset. If the asking price falls below a certain point, it may not be worth selling the asset at all. Thus, the asking price is essentially an offer made to the seller of a currency pair.

Who benefits from the bid-ask spread？The difference between the bid and ask prices is referred to as the bid-ask spread. Spread is the difference between the bid and ask price. The bid-ask spread benefits several parties in financial markets including market makers, brokers, investors, and exchanges. Suppose the "Ask" price on the EUR/USD pair is 1.16450 and the "Bid" price is 1.16400. The difference of 0.00050 is the spread.

Bid-Ask Spread: How It Works In Trading？

Bid-Ask spread is the difference between bid price and ask price of an asset. The difference between the two prices defines the spread. The larger the gap, the higher the spread. Spread values can be very small in a high liquidity market, but when the market is less liquid, spreads will be wider.

Both the bid and ask prices are displayed in real-time on the trading platform and are constantly updating. The variable difference between the two prices is a key indicator of the liquidity of the market and how much the transaction costs.

High liquidity in any market is usually caused by higher trading volume. High liquidity enables traders to buy and sell closer to the market value price. That’s why the bid-ask spread tightens in a more liquid market.

Types of Spread

Brokers can either offer fixed or floating spreads, depending on their policy.

Fixed Spread

Fixed spreads guarantee that you always know the precise cost of each trade, regardless of the state of the market. Another benefit of fixed spreads is that brokers cannot increase the spread in reaction to shifting market conditions.

Floating Spread

Unlike fixed spreads, floating or variable spreads change over time and have a tendency to vary. The current dynamics of supply and demand in the currency market as well as overall market volatility affect these spreads. Floating spreads frequently widen when market liquidity declines during important economic releases and bank vacations. However, they could be less than fixed spreads when the market is stable.

What’s considered a high spread in Forex？ A spread is regarded as high when there is a significant difference between the bid and ask price. A spread that is higher than usual usually indicates that the market is erratic or that there is less liquidity as a result of trading beyond market hours.

Differences in Bid-Ask Spreads between Trading Sessions

As all of us know, the Forex market consists of different trading sessions throughout the day. The sessions are as follows:

Sydney
Tokyo
London
New York

Depending on the trading session, a currency pair’s bid-ask spread may change.

The London and New York sessions often have the lowest bid-ask spreads since they have the highest trading activity.

However, the spread might widen during the three hours that follow the conclusion of the New York session and before Tokyo opens. Although it can affect the major currency pairs as well, this is particularly true for some of the currency crosses and exotic currency pairs.

Sydney's session begins immediately after New York's ends, but because it is far less liquid than the latter, spreads are substantially wider. Three hours later, when Tokyo goes live, the volume increases up and most spreads return to normal.

If you intend to trade during this three-hour window, it is crucial to keep this in mind. In fact, regardless of the current trading session, you should always verify the bid-ask spread before placing a transaction.

What Causes Bid-Ask Spreads to Vary？

Bid-ask spreads change depending on the currency and the broker. Understanding the type of rate, you should receive for a specific currency conversion is a smart idea, along with finding the best broker.

Market volatility: Bid-ask spreads typically widen when market volatility is high because buyers and sellers become more cautious and demand larger premiums for taking on risk.
Liquidity: If there are fewer buyers and sellers in the market for assets with low trading volumes and low market capitalization, the bid-ask spreads on those securities may be greater. This makes it more difficult for traders to acquire or sell big blocks of shares without altering the price.
Trading costs: The costs related to trading might have an impact on bid-ask spreads. For instance, increased costs from exchanges for executing deals in particular securities may result in broader bid-ask spreads.
Information asymmetry: The amount of information available to market participants can also be reflected in bid-ask spreads. Wider spreads may result if certain traders demand a larger premium to trade because they have access to information that other traders do not.
Market maker competition: Depending on the quantity and activity of market makers, bid-ask spreads might change. One market maker may have more pricing power and offer larger spreads if there are fewer market makers for a security. Multiple market makers may compete with one another to offer tighter spreads.

Overall, bid-ask spreads might differ for a variety of reasons, but they ultimately capture the market’s supply-demand equilibrium as well as the expenses and risks involved in trading.

How to take Advantage of the Bid-Ask Spread？

Regardless of the trading strategy being followed, it’s always ideal to trade at the best price possible. Be careful and try to get the best price whenever possible. However, in fast-moving markets, where you need to get into or out of a position quickly, you’ll sometimes need to choose the best available price to enter a trade.

Most forex brokers require that you pay the spread when entering and exiting a position. That’s why forex day traders seek forex brokers with low spreads. The bid-ask spread is considered as a hidden trading cost. It can work against you, but it can work for you only if you pick your entry points carefully.

The bid price is the buying price that buyers offer for an asset. Usually, traders tend to buy assets as cheaply as possible and achieve a large bid-ask spread through higher ask and lower bid prices. While an ask price is the selling price offered by sellers for an asset. They usually want to sell their assets as expensive as possible.

Disclaimer: This post is from Aximdaily and it is considered a marketing publication and does not constitute investment advice or research. Its content represents the general views of our editors and does not consider individual readers personal circumstances, investment experience, or current financial situation.

Bid and Ask