The Bid, Ask and Spread
All forex quotes are quoted with two prices: the bid and ask.
What is “Bid”?
The bid is the price at which your broker is willing to buy the base currency in
exchange for the quote currency.
This means the bid is the best available price at which you (the trader) can sell to
the market.
If you want to sell something, the broker will buy it from you at the bid price.
The “bid” is the price at which you can SELL the base currency.
What is “Ask”?
The ask is the price at which your broker will sell the base currency in exchange
for the quote currency.
This means the ask price is the best available price at which you can buy from the
market.
Another word for ask is the offer price.
If you want to buy something, the broker will sell (or offer) it to you at the ask price.
The “ask” is the price at which you can BUY the base currency.
bid/ask spread on metatrader platform
Here’s an illustration that puts together everything we’ve covered
When you buy a currency, you will use the offer or ASK price.
When you sell, you will use the BID price.
Summery on Bid and Ask
Remember that the terms bid and ask are from the forex broker’s perspective,
not yours.
● When you’re buying, you’ll pay what the broker is asking.
● When you’re selling, you’ll need to accept what the broker is bidding.
To make it less confusing for traders, most forex brokers display “Sell” instead of
“Bid” and “Buy” instead of “Ask” on their trading platforms.
What is “Spread”?
The difference between the bid and the ask price is known as the SPREAD.
The spread is how “no commission” brokers make their money.
This spread is the fee for providing transaction immediacy. This is why the terms
“transaction cost” and “bid-ask spread” are used interchangeably.
Transaction cost (spread)
Formula,
Transaction cost (Spread) = Ask Price - Bid Price
For example, in the case of the EUR/USD rate of 1.1053/1.1051, the transaction
cost is two pips.
What types of spreads are in forex?
There are two types of spreads:
Fixed
Variable (also known as “floating”)
Fixed spreads are usually offered by brokers that operate as a
market maker or “dealing desk” model while variable spreads are
offered by brokers operating a “non-dealing desk” model.
Variable spreads
Non-dealing desk brokers get their pricing of currency pairs from
multiple liquidity providers and pass on these prices to the trader
without the intervention of a dealing desk. This means they have no
control over the spreads. And spreads will widen or tighten based
on the supply and demand of currencies and the overall market
volatility.
spreads widen during economic data releases as well as other
periods when the liquidity in the market decreases
For example, you may want to buy EURUSD with a spread of
2 pips, but just when you’re about to click buy, the U.S.
unemployment report is released and the spread rapidly
widens to 20 pips!
How to calculate Spread cost (or actual transaction cost)
Formulas,
1- Spread cost = Pip size × Lot size
OR
2- Spread cost = Spread in No of Pips × No of Lot size × Pip value per Lot size
Note: when calculating spread cost, brokers quote to 5 decimals (meaning including the pippete)
for precision.
Note: Transaction cost isn't the same as Actual transaction cost and so as Spread and
Spread cost.
Look close in this example, a pip is written in two ways?
Pip in size (0.00014) and Pip in numbers (1.4)
Cont
In the quote above, you can buy EURUSD at 1.35640 and sell EURUSD at 1.35626.
This means if you were to buy EURUSD and then immediately close it, it would result in a loss of (0.00014)
or 1.4 pips
To figure out the total cost if we are trading 1 mini lot (10,000) we can use both formula 1 & 2.
Formula 1,
Spread cost = Pip size × Lot size
= 0.00014 × 10,000
= $1.40
Formula,
Spread cost = Spread in No of Pips × No of Lot size × Pip value per Lot size
If you increase your position size, your transaction cost, which is
reflected in the spread, will rise as well.
For example, if the spread is 1.4 pips and you’re trading 5 mini lots,
then your transaction cost is $7.00.
1- Spread cost = Pip size × Lot size
0.00014 × 50,000 = $7
2- Spread cost = Spread in No of Pips × No of Lot size ×
Pip value per Lot size
1.4 × 5 × 1 = $7