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Difference Between Bid And Ask Price Exchange Rates

March 2, 2016 by admin in Tips, Trading

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In the Forex market every cost movement is connected with changes between ask and bid. Different news usually influences the demand increase and supply cutting, and vice versa. Let’s define the main terms to better interpret the FX mechanism.

What is bid and ask price?

What a seller demand is called ask price; bid price is what a trader is ready to pay. A bargain is struck when either a buyer agrees with the ask price, or a seller is ready to sell at the suggested bid price. In other words, the exchange-value of a currency increases if there are more buyers than sellers, because buyers quote a higher cost. And on the contrary, if there are more sellers than buyers, a descending trend occurs.

The difference between bid and ask is called spread. Most investors pay much attention to it, as it covers unexpected expenses while trading with shares, foreign exchange, options and so on.

Main points about spread

Question Answer Explanation
1 What factors influence spread? 1. liquidity
2. difference between bid and ask price
A spread’s size is defined by liquidity’s level, as well as bysupply and demand on a particular financial instrument. The more liquid the instruments are, the more active traders work, the narrower the difference in costs is.
2 What expenses does a spread cause? big and small If a trader opens deals rarely, the spread expenses are insignificant. But an active trader may meet with losses, if he works with several orders every day. Before making a sell or buy bid, it’s worth analyzing cost difference. Such analysis should be included in a trading strategy.
3 Why may
spread become bigger or smaller?
a tumble in stock market prices The gap between figures becomes bigger, when there’s a great drop in prices owing to bid-ask price’s imbalance, as sellers accept an offer, and buyers are waiting for lower figures. In the end, market participants enlarge bid versus ask to minimize risks and reduce the quantity of investors.

How to read a calculated spreads?

The difference between currencies’ prices is represented in quotation. It is the price of one currency’s unit represented in the other one. The first currency in pair is called base, the second — quoted.

Quotation consists of 2 figures: the first one means bid, and sell (or ask) is the other one. For example: EUR / USD = 1,2490. It means that 1 Euro (bid) is equal 1,2490 American Dollar (ask).

Shares can be depicted like that: $8,85 / $ 8,9 (the first figure is a bid, offer is the second figure). The spread is 5 cents (0,50%). If a trader buys a share for $8,9 and sells it for $8,85, though it were a casual deal or planned trading course, then he looses 0,50% from the price. But if he sells it later for $9,95, then he gets 0,50% of profit, according to the simple formula.

Handy hints and tips

1. It is better to use a limit It allows putting a cost limit on a financial instrument in comparison with market orders that suggest an immediate transaction according to the dominant market price. Though such orders do not give any guarantees to be executed completely or maybe executed partly.

Orders can be different according to what a trader needs. For example, what is a limit order to sell? It is a limit on the lowest price that a trader sets for an instrument. It means that an instrument won’t be sold cheaper than the set limit order is. Still the execution may not happen or it occurs, but not partially.

If a trader wants the safest execution, then he can set stop-limit sell order. Before giving a definition for this term, it is better to answer the question: what is a stop limit? It is actually a combination of buy or sell stop order and limit order, which is displayed in 2 figures, where 1st is the stop level and the second is the buy or sell limit.

Sell stop limit will not allow the deal to be made, if the price falls lower than a trader is ready to sell. In fact, it is a complete control over situation.

2. It is worth avoiding liquidity expenses. Using a stop limit (sell or buy) will help to increase liquidity without additional expenses.

3. When the spread is evaluated in percentages, it is easier to control how much a trader may lose. When the margin is     used, the gap between buy-sell bid can be quite substantial.

4. A smaller cost difference is of high importance for retail foreign exchange traders, who cannot benefit from the 1-cent spread, like participants in the interbank market do. In this case, when traders quote bid, ask should not be very     different, otherwise transaction will bring no profit.

To sum up, the spread is a vital part of technical analysis, because it contains “hidden” losses while trading. A wide gap between bid and ask price may reduce income and increase the financial loss. To smooth the influence of the spreads traders use stop-limit (sell or buy) orders. Brokers also pay their role in this game. So, a trader should trust his broker. That is why there is broker’s rating, like on Global Forex Awards, where only actual information is clearly depicted.