Bids, Asks, and Spreads

Bids, Asks, and Spreads

Once you are comfortable with the concept of currency pairs, you are ready to consider the composition of a FOREX quote. These quotes are generally two-sided. The two sides of the quote are the bid and ask, which is can also be called the bid and offer. The bid is the price a seller is offering for a currency, the ask is the price a seller is willing to take for the currency. The difference between these two numbers is called a spread. Spreads are quoted in pips, which are the smallest unit of difference between the two currencies in the quote. If the quote between GBP/USD at a given moment is 1.5354/6, the bid is 1.5354 and the ask is 1.5356, which makes the spread equal 2 pips, the difference between the 4 and the 6. If the quote is 1.53545/6, then the spread is going to equal 1.5 pips.

The spread is how brokers make their money. Wider spreads will result in a higher asking price and a lower bid price. The end result of this is that you will pay more when you buy and get less when you sell, making it more difficult to realize a profit. Brokers generally don’t earn the full spread, especially when they hedge client positions. The spread helps to compensate the brokerage for the risk it assumes from the time it starts a client trade to when the broker's net exposure is hedged (which could possibly be at a different price).

Spreads affect the return on your trading strategy in a big way. As a trader, your sole interest is buying low and selling high (like futures and commodities trading). Wider spreads means buying higher and having to sell lower. A half-pip lower spread doesn't necessarily sound like much, but it can easily mean the difference between a profitable trading strategy and one that isn’t.

The tighter the spread is the better things are going to be for you. But tight spreads are only meaningful when they are paired up with good execution. A good example of when this is not happening is when your screen shows a tight spread, but your trade is filled a few pips in the wrong direction, or is mysteriously rejected. Then it’s time to reconsider your broker.

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