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Lesson 4: Understanding the Bid Ask Spread

By: Informedtrades.com Lesson 4: Understanding the Bid Ask Spread In our last lesson we looked at what an increase or decrease in the quote for a particular currency pair means to us as traders of the forex market. In today's lesson we are going to continue our discussion on the logistics of forex trading with a look at what the bid and ask for each currency pair means. In most financial markets there are always two prices for a particular financial instrument at any one time which are known as the bid and the ask price. The bid price is the price at which the market maker (the actual entity that is on the other side of your trade) will buy and therefore the rate at which you the client can sell. The ask price is the price at which a market maker will sell and therefore the rate at which you the client can buy. The difference between the rate at which you can sell (the bid) and the rate at which you can buy (the ask) is referred to as "the spread". Market makers such as the people that sit on the floor of the New York Stock Exchange in the stock market make their money from the spread, or buy charging traders more when they sell a stock than they do when they buy a stock. Although this is changing with the advent of online trading platforms, the concept of a bid and ask price is foreign to most, because traders are most familiar with the stock market where they have traditionally called their brokers whenever they wanted to place a trade who then placed the trade on their behalf with the market maker. When they call their broker they say they would like to buy x amount of xyz stock, the stock broker simply gives the client the ask price for that stock since the client has asked to buy. As you can see here however on this online stock trading platform, when requesting a quote for Jet Blue stock the quote window returns two prices, showing both the bid and the ask. The stock market is in the process of going from indirect access where clients trade through a broker to get to the market maker to a more direct access environment where online trading platforms allow them to trade directly with the market maker. As the forex market for individual traders really started with the internet, the market did not have to go through the same transition. Because of this most forex trading platforms show both the bid and the ask price and make their money through the spread, charging clients zero commissions to trade. Now that we understand this lets login to our real-time demo trading platforms and look at some examples. If you have not registered for a free demo trading account yet I encourage you to pause this video now and click the free demo registration link above this video if you are watching on InformedTrades.com or in the description section of this video if you are watching on Youtube so you can follow along as well. Once logged into the platform you will see the quotes window where you can see that the current bid price for the EUR/USD currency pair is 1.5760 and the current ask price is 1.5763. This means that currently you can sell the EUR/USD at 1.5760 and buy at 1.5763. The difference between those prices is the spread. Moving to the right across the currency window we see that the USD/JPY currency pair is currently trading at 101.89 by 92 which is another way of saying that the bid for the USD/JPY is and the ask is 101.89 and the ask is 101.92 . This means that we can currently sell USD/JPY at 101.89 and buy at 101.92. As some of you may have noticed, there is a fifth digit there that I have not included in my examples. Don't be confused about this at this point as we are going to learn about in a future lesson. Now that we have a solid understanding of currency pairs, the currency quote, and the bid and ask prices the next thing that we are going to do is look at actually placing some currency trades. With this in mind the homework assignment for tonight is to place a trade on your demo trading account which would reflect the opinion that you think that the EUR is going to Strengthen against the US Dollar.