Hello, colleagues! This article deals with the concepts of Bid and Ask prices in forex, their definitions, and typical features.
If you understand what Ask vs Bid prices mean in forex, you can set buy or sell limit orders correctly and manage your trade successfully. For example, a correctly set order will not let the market bypass Take Profit or hit a Stop Loss order before the price goes in the right direction. Well, what is Bid and Ask price? Let us find out.
The article covers the following subjects:
Definition of Bid-Ask
Let us have a look at the market price on the example of the relations between the parties. There are always two parties in trading- a seller and a buyer. Supply and demand rule the market pricing. Sellers and buyers bargain to get the best price and make a profit. The buyer wants to buy cheaper, and the seller wants to get a higher price.
In the trading process, sellers and buyers seek to offer each other the most favourable prices for a trade so as to make a profit. The stock bid ask spread emerges from the difference between the Bid vs Ask stock prices. Since market participants do not always manage to agree on stocks bid ask, sometimes the spread widens because of a significant difference between bid vs ask price. The spread also grows in he situation of illiquidity. Traders do not usually aim at making money on the bid ask stock spread. The spread is a source of income for the brokerage company. Sellers, who set their price, benefit from the Ask, and buyers make a profit from the Bid stock. Traders could make profits due to a significant stock bid vs ask spread, the difference between the selling and the buying prices of an asset, i.e. price points or pips. What does bid and ask mean? Let me explain the concept of ask price vs bid price.
The trader who buys sets the desirable price. This is the bid price or the maximum price at which a buyer is willing to buy an asset. The buyer does not want to buy expensive, this is the logic of the law of supply and demand.
The trader who sells sets the Ask price. The Ask price is the offer price or the lowest price at which the seller is willing to sell a security. The seller is interested in selling it at a higher price.
Bid and Ask pricing
When there are reasons to raise the price for an asset, the seller increases the Ask price. The buyer, accordingly, understands that there is little chance to purchase the asset at the old price and agrees to raise the Bid price.
When the price of an asset falls, the process reverses. The buyer wants to buy the asset at a better price and reduces the Bid price, while the seller is forced to reconsider the expectations from the transaction and reduce the Ask price.
A transaction occurs when there is a buyer who is ready to pay for the asset the price that the seller wants, or the seller agrees to immediately sell the asset at the price set by the buyer.
How to calculate Bid-Ask spread
To calculate the bid ask price spread, you first need to know the current Bid price for an asset, then the current stock Ask price.
Next, you find out the difference in ask vs bid stock price. You subtract the Bid price from the Ask price. Thus, you can calculate the bid vs. ask spread for a particular stock or currency pair. Let’s look at the examples below.
In the LiteFinance client profile, the current Bid/Ask price can be seen in the trading instrument window on the right:
The Sell price is the Bid. In the above example, the EURUSD Bid price is 1.01900.
The Buy price is the Ask. In the above example, the EURUSD Ask price is 1.01903.
To calculate the bid ask spread, you need to subtract the selling price (Bid) from the purchase price (Ask). In our example, the Bid-Ask spread for the EURUSD is:
1.01900 – 1.01903 = 0.00003 or 0.3 pips
Bid-Ask price spread = Ask price – Bid price
In the MetaTrader terminal, you can call the Market Watch menu using the keyboard shortcut Ctrl + M to calculate the bid ask spread.
In the Market Watch menu that opens, Bid and Ask prices are displayed by default. To calculate the spread, the difference between ask and bid, you need to subtract the Bid stock price from the Ask price.
For example, for GBPUSD spread is:
1.21903 – 1.21895 = 0.00008 or 0.8 pips.
You can make it easier and turn on the spread display (it is optionable) in the Market Watch window. The spread will be calculated automatically, and you will see the result in the window right away.
To enable spread display in MetaTrader 4, you need to right-click on the Symbol | Bid | Ask field. In the menu that opens, find the Spread option and enable it. After that, a column with the current price spread for a particular security will appear to the right of the Ask price and will be marked “!”.
Example of Bid and Ask Spread
The screenshot below displays the difference between the bid vs ask prices.
In the example, the GBPUSD spread is 0.6 pips. To calculate the bid ask spread, you need to subtract the Bid price from the Asking price.
Recommendations on trading Bid and Ask in forex
Why do you need to consider the Bid price and Ask price in trading?
Now, you may wonder why should you know the difference between Bid and Ask price.
I am sure that almost everyone has come across a situation when you enter a sell trade, set a Take Profit at a particular level, and the price, having touched the Take Profit, reverses and the sell position remains open.
Or you have set a Buy Limit order. The chart price touches the level where you want to enter a buy trade, but the position doesn’t open and you miss the trend.
Why does it happen? Because you don’t take into account the Ask price in your trading. By default, a stock broker shows only the Bid price (demand) in the chart of any instrument. The Ask price always follows the Bid, but at a short distance that we do not see.
How to enable the display of the Ask price in the MetaTrader terminal
You can enable the display of the Ask price in almost any terminal. Have a look at the example of the popular MetaTrader 4 terminal.
To enable the display of the Ask line, you need to right-click anywhere in the chart window, then click on the Properties option. The properties window can also be called up using the F8 key.
Select the Common tab and enable the Show Ask line option.
In other trading terminals, the Ask line can be enabled in the same way. This option is useful for traders who trade instruments with a wide spread.
How to avoid a spread trap
Spread traps can be roughly divided into three groups:
The broker does not activate your pending Buy Limit order, although the price seems to have reached the desired price level in the chart.
Stop Loss is triggered for a sell trade, although the price in the chart has not reached the level at which the SL was set.
Take Profit for a sell trade does not work, although the price in the chart has touched the TP value you set.
Such traps occur if a trader does not take into account the spread of the instrument when placing the orders.
Case №1: the broker does not activate the pending Buy-Limit order.
This can happen if the price in the chart (Bid) touches the level of your pending order, but the Ask price which is not shown in the chart by default doesn’t reach the level of your order. You should always remember that the purchase is executed at the Ask price, and a sale is performed at the Bid price. When a Buy Limit order works out, only the Ask price is taken into account.
For your Buy Limit to work, you should place it above the desired level, at a distance equal to the current market price spread. When the order is activated the chart will go a little lower than the desired buy price, but the buy position will definitely be opened.
Case № 2: A Stop Loss works out for a sell although the price hasn’t reached the SL level.
This happens when you do not consider the spread and set a stop order order directly at some level or at the price of the previous high. Then the price, when approaching the level of your stop loss, can exit the trade before reaching the mark where you predicted the exit with a loss.
To avoid this, remember that a stop loss works out at the Ask price (buy price).
To close the sell position, you need to open a purchase of the same volume. The price difference will show the profit or the loss, that is how the market works.
Supposing you have a sell position opened, or you plan to enter a sale with the Sell Limit. When the price reaches the Stop Loss level, the sell trade will be exited. To close a sell position, you need to open a purchase with the same volume. A stop loss order for a sell trade means a buy trade entered at the Ask price.
To avoid triggering the Stop Loss for a sell trade, set the SL above the local high at the distance equal to the spread.
Case № 3: Take Profit doesn’t work out for a sell trade although the price has touched the TP level in the chart.
The problem is that the trader does not take into account the Ask price in trading. As we found out earlier, the Ask price is the purchase price. To close a sale, you need to open a buy with the same volume. A Take Profit is a common purchase of a tradeable asset with the same volume as the trade entered in order to exit a sale. That is why the Take Profit order will work out at the Ask price. The Ask price is usually a little higher in the chart than the Bid price; the difference between the prices is the spread. If you do not take into account the spread, the trade may not be exited.
To avoid such traps you should set a Take Profit for a sell a little higher than the desired price, at the distance equal to the spread.
Ask and Bid: Summary
A market order is not always suitable for trading, as a trader may not be in the market when favorable prices appear. One could use a limit order in this case, and it is important to take into account the Bid and Ask price and the bid/ask spread.
The bid-offer spread is essential in trading as it shows the difference between the ask and bid price. The market maker profits from the spread and the transaction cost. The trader should take into account the bid ask spread so that he/she can use pending orders and enter trades at the most favourable prices. If you understand bid price vs ask price and consider the bid ask spread, you will avoid the traps covered in the article and increase the potential profits.
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.