The bid and ask prices are the most basic measurements of forex trading. While other concepts like pips, spreads, volatility etc., may not be immediately apparent to new traders (except if explained), these two terms should be known even by the newest trader.
Two individual currencies are usually paired together to facilitate trades between traders who wish to use one currency instead of another for whatever reason. These currency pairs show up on programs as part of price information, usually with two letters to indicate what the pair represents.
Some common examples include GBP/USD (British Pound vs US Dollar), EUR/GBP (Euro vs British Pound) and AUD/NZD (Australian dollar vs New Zealand dollar). With these examples, it is possible to compare each pairing directly against each other because they represent equal amounts of their respective currencies. 1 GBP equals 1 USD since both are supported by Britain’s Bank of England and the United States Federal Reserve (respectively).
While this correlation holds, it is not constant. It can vary over time based on the insights of traders, economists and other financial experts, causing some pairs to have higher or lower values than others against another pairing. For instance, EUR/GBP might be 0.80 at the beginning of a month but drop to about 0.72 towards its end due to shifting market conditions, reflecting an 18% difference between the two currencies seen in the pair’s value during these months.
Since currency trading is done through trading platforms designed around using certain currencies together for different purposes, trade signals are usually displayed as a percentage. One number denotes buying power while another denotes selling power; you can see it here.
The ‘bid’ denotes buying power, while the ‘ask’ denotes selling power. The difference between them is whether or not that price includes the trading fees, which are part of each transaction in a trading platform.
For example, suppose a request is made for GBP/USD at 1.2535 bid and 1.2540 ask. In that case, this does not include any costs associated with trading itself, which means that the actual cost for this trade would be somewhere around 1.2570-75 because of market spreads and other factors usually taken into account during the execution of trades.
To make money from these transactions, you need to understand the spread, which is the difference between the ask and bid prices. In this instance, GBP/USD has been quoted as having a 0.05 bid-ask spread.
The ‘spread’ can be negotiable in certain circumstances if traders approach their brokers about it directly though they are not obligated to do so since they have already given a quoted price based on their rules and regulations regarding bids and asks.
To reach one of the two prices, traders will need to set up limit orders by placing them at specific price points. Allowing them access to the other side of that trade without competing against multiple other traders who may have placed buy or sell orders nearby. Offering an advantage over simple market orders, which are requests executed at the current market price, means that traders who place buy or sell orders can affect how much profit they will make on these transactions.
Since bid and ask prices change over time while some traders might not place limit orders, it is essential to remember that these numbers are only relevant when they stand on their own instead of being part of an entire transaction. The example given earlier where buying GBP/USD at 1.2535 means something very different from that quoted as 1.2540 bid, 1.2590 ask.
Making money off these differences in price is generally considered arbitrage which has its disadvantages since trading fees will almost always cause it to end up with a loss after expenses are taken into account. It is still possible for traders to pursue arbitrage strategies. Still, they need to be careful about how much they place in the beginning to recoup the transaction costs involved in these types of high-risk transactions.