One of the main components of every type of trading, including Forex, commodities, stocks, etc. is the negotiation process. It’s when two sides – buyers and sellers of a certain asset – try to determine the best price that will satisfy their needs.
Traders and service providers engage in this process of negotiation by quoting (offering) the bid and ask prices. A bid is essentially the maximum price that the buyer is willing to pay for the asset; Ask is the minimum price at which the seller is willing to sell the asset that they own.
The process of exchanging bid and ask prices on certain assets finally concludes in a price that is acceptable for buyers, as well as sellers. Usually, buyers want as low price on the asset as possible, while sellers want to get the highest price.
The bid and ask prices are usually different from one another – bid price being low and ask price being high. The difference in the bid and ask price foreign exchange market is called a spread.
Traders want to receive payouts
The main reason why people get into trading is to receive payouts from the process – that’s the motivation that lies behind every single trade. It doesn’t matter whether we are talking about service providers or individual traders, they want to buy and sell securities at a beneficial price to them.
And to determine those prices, the two sides – buyers and sellers – engage in the negotiation process. That is where we encounter two of the most important elements of every trade – the bid price and ask price in forex. Here’s how they work:
- A bid price is offered by a buyer of a certain asset. It represents the maximum amount of money that they are willing to pay for it and they usually try to make it as low as possible;
- An ask price is offered to a buyer of an asset. It represents the minimum amount of money that the buyer is willing to take for it and they tend to demand as high a price as possible.
Now, this might seem a bit difficult to understand. So, here is an example that shows the bid and ask rate in Forex in simpler terms:
The ask and bid quote example
Let’s assume there is a trader named Josh who wants to buy a USD/JPY currency pair for, say, 100,000 Japanese yen. And after he has bought the pair, he’ll wait some time until the bid ask exchange rate increases to sell the pair and receive a payout. To do that, Josh finds a service provider – a broker, who has satisfying trading conditions for Josh.
Now, one would assume that the price for buying and selling the USD/JPY pair should be the same. So, if Josh buys about 911 dollars at the asking price of 109.69, he should be able to sell that same amount of yen and get 100,000 yen back, right?
No, that’s not how this system works, even though it might seem logical to many people. Instead of the same bid ask Forex price offerings, the two prices are different from each other.
Therefore, if Josh buys 911 dollars with an asking price of 109.69, that will most probably be the maximum amount he will get as a result of the given trade with 100,000 yen. However, if Josh decides to sell the dollars and buy yen again, he’ll probably get fewer of it back.
For the sake of this example, let’s assume that the bidding price is 109.67. This means that the buyer will pay Josh 99,909 yen back – assuming that the overall exchange rate remained the same at that time.
What does buying/selling a currency pair mean?
This real-life bid and ask price foreign exchange example of Josh and his trading experience on the foreign exchange market demonstrates how the bid and ask prices work. Now, there is one more thing to clarify: when we are talking about the Forex bid ask price, and also mention a certain currency pair like the above-mentioned USD/JPY, it means that we’re buying US dollars with Japanese yen. In general, buying a currency pair means just that: traders use the second currency – a base currency – to buy the first currency in the pair.
Now, let’s talk about the price point which is satisfying for sellers and buyers of these assets. As we mentioned earlier, the bid price is the maximum that a buyer is willing to pay for an asset. This means that there is a certain point beyond which the price becomes too large for a buyer (usually a broker) to pay. And since every broker wants to buy assets as cheaply as possible, they try to lower the price by negotiating with the seller.
On the other hand, the asking price, as you already know, is the minimum that a seller is willing to receive from the buyer for an asset. And when the asking price goes lower than a certain point, it’s just not worth selling at all. Therefore, the asking price is basically what the offer price means: a certain price offered to the seller of a pair.
So, the negotiation process is where traders and service providers determine a certain price which is satisfying for both parties – sufficiently low for buyers and sufficiently high for sellers.
Forex ask and bid price difference – who benefits from it?
So, one of the things that are most apparent from this example is that the bid price is almost always lower than the asking price. That is because the difference between bid and ask prices is what generates a payout for the service providers/brokers.
To get back to our bid ask currency example, when a provider offered Josh an asking price of 109.69 but decreased the bidding price at 109.67, the difference of 0.02 – which is considered 2 pips for JPY-based pairs – resulted in a payout. Therefore, in real numbers, a service provider received $2 from the trade.
The difference between the bid and ask prices is called a spread. In most cases, brokers and other service providers in Forex don’t have commission fees on trading. That’s because there are spreads that can do the same thing – provide financial support to the broker.
The bid and ask prices make up the trading process
So, to put everything in a nutshell: traders and service providers are engaged in a constant negotiation process where they try to set favorable prices. For one party, the price needs to be as high as possible, while for the other – as low as possible.
That’s where the bid and ask price foreign exchange kicks in. A bid is a buying price that the buyer offers for an asset. Usually, they want to buy assets as cheaply as possible and achieve a large bid ask spread through higher ask and lower bid prices.
An ask is a selling price offered by a seller for an asset. They usually want to sell their assets as expensively as possible, and they’re also trying to negotiate that price with their trading partners.
The difference between the bid and ask prices is called a spread. Spreads are what generate payouts for service providers and since the majority of them don’t have commissions, that’s what their financial stability lies upon.
FAQ on the bid and ask prices in Forex
Who benefits from a large bid ask price in Forex?
Spreads reflect the difference between the bidding and asking prices of assets, be it currency pairs, commodities, or something else. They exist for a reason.
When a trader buys an asset, they usually pay a higher price and get fewer amounts of it. On the other hand, when they try to sell that asset, they will receive a smaller price and still get fewer amounts of it.
In Forex, the majority of service providers don’t have commissions on their services and the only source of income for them is spreads – the difference in prices that is left to them. Therefore, the larger the spread size, the better for a service provider.
What is an ask price?
In trading, there are two elements that constitute the whole price negotiation process: the bid and ask in Forex.
An ask is the minimum price that the seller is willing to take for their asset. For example, if a seller has a EUR/USD currency pair, they might set a price limit of 1.2346: if the price increases, it will mean that they will get less money for their asset which won’t be beneficial to them.
Is a bid higher than ask price?
In trading, there is a difference between the bid and ask prices for a reason. Usually, the bidding prices are lower and the asking prices are higher. For instance, the EUR/USD currency pair might have a bidding price of 1.2344 and the asking price of 1.2346.
The difference of 0.0002 is called the bid and ask price Forex spread with an amount of 2 pips. And those 2 pips are what generate profit for service providers. In fact, the majority of brokers and other providers are based on the income from spreads because they don’t impose additional fees on traders.
So, if the bid price suddenly becomes higher than the ask price, there will be nothing for a provider to get a payout from. That’s because they sell assets more expensively – so that traders can get fewer amounts – and buy them more cheaply – so that they can get larger amounts. Therefore, the bid price is almost never higher than the ask price.
What does buy and sell mean in Forex?
Buy and sell are the position types in Forex. Buy is a position where you purchase a certain instrument for an ask price, whereas sell is a position where you sell an instrument for a bid price. And what are is bid and ask price in Forex? Bid price is the amount of money your broker is willing to give you for buying an asset from you, while the ask price is the amount of money you’re required to pay to your broker for an asset. Generally, the ask rate in foreign exchange is higher than the bid rate, simply because a broker needs to run on some sort of a commission, which is called a Forex bid ask spread.