Understanding What is Bid Price, Ask Price and Spreads
Understanding bid price, ask price, and spread is fundamental for any forex trader. These terms are crucial for executing trades effectively and managing trading costs.
There are always two prices when you trade the forex market, the stock market, or any other financial market.
Bid Price – The price that you use as your reference when you are going to enter a Sell position.
Ask Price – The price that you use as your reference when you are going to enter a Buy position.
So, just like going to a money changer to exchange your money, you will see that they have both the Sell and Buy prices for a specific currency.
Let me explain further using this chart:
This chart features the EURUSD, and you can see two prices: the Bid price on the left and the Ask price on the right.
If you want to open a Sell position, you can use the Bid Price as your reference. If you want to open a Buy position, you can use the Ask Price as your reference.
Let’s use that as a guide.
There is a Bid Price of 1.07962 and an Ask Price of 1.08008 for EURUSD.
When you click Sell, you need to focus on the Bid Price (1.07962) as your reference.
Let’s say the price goes down to Bid 1.07500 and Ask 1.07523. This means you are getting a profit. When you click close for this example, which means that you are “clicking” Buy to close the position, you must focus on the Ask Price as your reference.
The same concept applies when you plan to Buy EURUSD. When you click Buy, the price you must focus on is the Ask Price (1.08008).
If you want to close the position, click Sell to close the position and focus on the Bid Price as your reference.
Spread
Now that you know what Bid and Ask Prices are, it’s time you learn about the spread: the difference between the prices.
From this example, you can see that the EURUSD has a spread of 4,6 pips.
The spread plays an important role in your trade because this will affect your result. Some brokerage firms may charge you a little, and some don’t charge any fees to trade. In this case, your transaction cost will be in the form of a spread.
Let’s explore further.
If the spread is your transaction cost, then a wider spread between the Bid and Ask price means the transaction cost is higher.
Example:
If you refer to this EURUSD spread, the transaction cost is 4,6 pips when buying or selling 1 standard lot of EURUSD. Because the pip value of EURUSD is 10USD per pip per lot, your transaction cost will be 46 USD.
Every time you enter a position in EURUSD, you must pay this transaction cost first before getting the profit from the price movement. Remember that the spread may change wider or tighter based on the market volume.
Note that your transaction cost to cover is higher if you have a wider spread. If your spread is tighter, your transaction cost to cover is lower.
Conclusion:
Understanding the bid price, ask price, and spread is essential for forex trading. These concepts help you determine the cost of trading and the potential profit margins. By mastering the bid-ask spread, you can make more informed trading decisions and improve your overall trading strategy.
FAQ
Q: What is the bid price in forex trading?
A: The bid price is the highest price a buyer is willing to pay for a currency pair.
Q: What is the ask price in forex trading?
A: The ask price is the lowest price a seller is willing to accept for a currency pair.
Q: What is the spread in forex trading?
A: The spread is the difference between the bid price and the ask price, representing the broker’s profit.
Q: Why is understanding the spread important?
A: Understanding the spread helps traders manage their trading costs and determine the most cost-effective times to trade.
Q: How do brokers make money from the spread?
A: Brokers earn money by charging the spread on each trade, which is the small difference between the bid and ask prices.
Q: Does the spread remain constant?
A: No, the spread can vary depending on market conditions, liquidity, and the currency pair being traded.
Q: How can I minimize the impact of spreads on my trading?
A: To minimize the impact of spreads, trade during high liquidity times and choose brokers with low and competitive spreads.
Ready to improve your forex trading knowledge? Open a demo account with VT Markets today and practice trading with virtual funds. Join VT Markets and start your journey to becoming a proficient forex trader!
