Once you begin Forex trading, you may find traders discussing bid, ask and spread. These are terms which are simple yet very crucial since they will make you know the direction of movement of prices and the expense of trading.
It may seem odd at first, but you get to know these notions and all of Forex makes a lot more sense. We can simplify it into layman-language.
What Is the Bid Price?
The bid price is the price, where the market (or your broker) will purchase a currency of yours.
Think of it this way:
- You are trying to sell a pair of currencies.
- The price that you will get on selling is the bid price.
Example:
EUR/USD
Bid = 1.1050
Each Euro sold translates to 1.1050 US Dollars.
Bid price is always slightly lower than the ask price. We’ll explain why next.
What Is the Ask Price?
The ask price (also known as the offer price) is the price at which the market is ready to sell you a currency.
Think of it this way:
- You would like to purchase a currency pair.
- The price that you are going to pay to buy it is the ask price.
Example:
EUR/USD
Ask = 1.1052
At 1 Euro, you will be paying 1.1052 US Dollars.
Note that ask price is a little higher than the bid price. The difference is not big--it is the spread.
What Is the Spread?
The difference between the ask and bid price is the spread.
Example:
EUR/USD
Bid = 1.1050
Ask = 1.1052
Spread = 1.1052 – 1.1050 = 0.0002, or 2 pips.
The spread is in effect the trading cost. Money made by brokers comes as a spread rather than through an additional commission (thought there are brokers who charge commissions).
Key points about spreads:
- The spreads tend to be lower in major currency pairs since they are the most liquid.
- Smaller trading volume has been seen to result in exotic currency pairs with bigger spreads.
- The change in spreads can vary across the day, generally less in times of active trading such as London/New York.
Why Bid, Ask, and Spread Matter
It is significant to understand bid, ask, and spread since:
It influences your profits and losses.
When you enter a trade you are marginally at a loss due to the spread. That cost has to be compensated by the market moving towards you.
It assists you in the selection of currency pairs.
Day traders and beginners should use pairs that have narrow spreads (such as EUR/USD).
It impacts trading strategy.
When trading with high frequencies, spreads are taken into account carefully by scalawags and high-frequency traders because minor variations make a difference.
Simple Example
Suppose you would prefer to purchase EUR/USD:
- Ask price = 1.1052
- Bid price = 1.1050
- Spread = 2 pips
You buy 1 mini lot (10,000 units). Each pip is worth roughly $1.
- Spread cost = 2 pips × $1 = $2
This implies that you begin trading at a cost of 2D that is as a result of the spread. When the market shifts in your favour, you will be able to make a profit more than this.
Final Thoughts
Bid, ask and spread are not complicated terms; however, they are very crucial to Forex traders.
- Bid = the price you sell at
- Ask = the price you buy at
- Spread = difference between them, cost of trading on your part.
These basics will enable you to trade wiser and control costs and select the optimal choice of currency pairs to implement your strategy.
At first, being a novice, you will understand how to use bid, ask and spread and then you will have a much better understanding of how Forex market functions.
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