- In the Forex market—the world’s largest and most liquid market—exchanges happen when a buyer and a seller agree on a particular currency’s price per unit
- Top currencies stay highly liquid during trading hours, making each trade almost instantaneous
- Traders can buy or sell an asset at two different prices: bid and ask
- The bid price is the highest price a buyer is willing to pay for a security, while the ask price is the lowest price a seller is willing to sell his security
- The bid price is always lower than the ask price
- Forex traders should consider their bid-ask spread when trading because it can change throughout the day depending on market activity and liquidity
Forex stands for ‘foreign exchange’. The forex market is a global market where you can buy or sell currencies, and the currency being traded does not have to come from your home country.
When trading, there are two fundamental prices: the bid price and the ask price.
What is bid and ask?
Bid and ask prices, also described as ‘bid-ask price’, are two essential variables in forex trading. These prices exist on every currency pair, and the difference between these two prices is known as the bid-ask spread. You may have heard these terms before without knowing what they mean, so let’s explore what they are.
What is forex trading?
Before understanding bid and ask prices, we have to cover the basics.
Forex trading involves the exchange of two different currencies or the exchange of foreign money for local currency. Every time you buy or sell a currency, that is considered a forex trade.
Most common forex trades revolve around casual shopping and travel. When you decide to visit New York on your vacation and buy United States dollars in exchange for Australian dollars, you are essentially trading forex. However, this article will discuss forex trading from another angle.
Every form of trade takes place when there is a willing buyer and seller. The same goes for trading currencies: there needs to be at least one person willing to buy and one person willing to sell.
Unlike other assets like stocks or gold, currencies can be traded 24 hours per day, five days per week. This makes it convenient for part-time traders who cannot make time during regular business hours.
Who trades forex?
Forex traders can be categorised into professionals and non-professionals.
Professional traders trade forex for a living or as a part of their full-time job. Non-professional forex traders are those who do not trade in a professional capacity. This could be anyone with the money and the interest to invest.
Forex traders nurture their understanding of the global economy or share a motivation to learn about foreign relations.
Once a forex trader does his due diligence and decides on a trading strategy, they invest their capital with a broker or another financial institution. When the money settles in their trading account and they are ready to open their first position, traders will see a bid and ask price flashing next to every currency pair in their dashboard.
The same two prices show up on the graph next to the price, usually forming two lines. One line represents the bid price, and the other the ask price.
Requesting the ask price in MT4
In MetaTrader 4, the default dashboard sometimes shows only the bid line on the graph, so users have to request the ask price manually.
- Right-click on the graph
- Select ‘Properties’
- Click on ‘Common’
- Check the ‘Show Ask Line’
A red line should now appear on your screen, representing the ask price.
The difference between bid and ask
Every time a trader exchanges foreign currency, someone sits on the other side of that transaction and makes the opposite trade. This someone can be an individual, broker, bank or any other financial institution.
If you are interested in buying American dollars with Australian dollars, you will need to find someone willing to sell them for your requested price before the trade can be made. As there are often several buyers and sellers at any given time, there will be competing offers of what that particular currency will cost.
The difference between these competing offers will form two prices, forming the bid-ask spread.
- The bid price is the highest price traders are willing to buy a security
- The ask price is the lowest price traders are willing to sell it
The bid price is always lower than the ask price.
Examples of trading bid price vs ask price
The first one lists AUD available for purchase at 0.7468, and the other option values the same AUD at 0.7462. In this case, the bid price for USD/AUD is 0.7462, and the ask price is 0.7468.
Buying one lot (100,000 units) of the Australian dollar at 0.7462 would represent going long on $746,200,00. Buying (or long) means that you are investing in the potential growth of the currency pair, and long positions of AUD/USD start at 0.7462.
In this case, traders can profit if the bid price moves higher than 0.7462.
Shorting the same lot at 0.7468 would represent shorting $746,800,00. Short positions open at 0.7468.
Traders can profit if the ask price moves below 0.7468.
Why is the bid-ask spread important to forex traders?
Bid-ask spread plays a crucial role in forex trading. Starting positions for buying or shorting currencies can fluctuate based on supply and demand. Consideration of this fluctuation is important to forex traders because it makes some currencies more expensive than others.
For example, Brazilian Reals are not in great demand even if they are trading up against the US Dollar, so the bid-ask spread for these currency pairs could be higher than in-demand currency pairs.
Certain times of the day can also have more sellers and lower bid-ask spread during certain hours.
In that case, trading EUR/GBP during the Central European Time (CET) business hours can make for more favourable trading conditions. This is especially true during the overlapping times when London, Frankfurt and other key European exchanges are open at the same time because the likelihood of higher volumes of EUR/GBP is more likely to be executed.
More trading activity and higher liquidity can bring lower spreads.
As more Pounds and Euros are exchanged during the European season, the bid-ask spread of the currency pair is lowered. Trading the same currency later in the day, during and after the Sydney opening bell, can increase the spread. In this case, the most unfavourable time for trading EUR/GBP would be late Sydney afternoon when it is early morning in London and European activity is low.
EUR/GBP is one of the most traded currency pairs, so its price should stay relatively stable throughout the day. This difference in bid and ask prices are more striking on less liquid currencies at odd times, like Brazilian Real and Norwegian Krone during the Pacific trading session.
The bottom line
The bid price is the highest price traders are willing to buy a security, while the ask price is the lowest price traders are willing to sell. Bid and ask prices are the entry points to forex trading and knowing how to evaluate the bid-ask spread is essential to every trader.
The difference between the bid and ask prices is determined by supply and demand for a given currency. Forex traders should consider their bid-ask spread because it can change throughout the day depending on how many buyers or sellers are present at any given time.
Rakuten Securities Australia (RSA) offers competitive spreads and demo accounts for traders of all levels. As all trading contains a certain level of risk, traders can open our free demo account and practise before placing real trades with their capital. Sign up for your free demo account today.