How successful is your forex trading strategy? For many people, forex trading is a hit or miss affair. They lack a solid knowledge on forex trading and rely on recommendations from other traders or sheer luck. Unbeknown to them, experimenting with trading can only take you so far in the forex trading game.
While there are a whole lot of concepts you should have mastery on to trade profitably, understanding the bid-ask spread in forex forms the core of any trading strategy. After all, the bid-ask spread determines the point at which a trader should either buy or sell a security. For this reason, this article analyses all there is about the bid-ask variations and how you can ramp up more profits from your trading overtures. Read on.
Definition of bid-ask spread.
Basically, currencies are traded in pairs and each pair has a two-way pricing known as a currency quote. The currency quote indicates the prices at which each of the currencies can be bought or sold. The price at which buyers are willing to buy a specific currency in the market is known as bid price. The ask price, on the other hand, is the price at which sellers are aiming to offload a given currency pair in the online forex market.
To take one random but illustrative example, suppose a EUR/USD pair is quoted as 1.2366/70. Then 1.2366 is the bid price and implies the price that you can sell 1 EUR for 1.2366 USD. If instead you're looking to buy the Euros, then you will pay 1.2370USD for the EUR. This is the ask price.
The bid-ask spread.
The difference between what a trader is selling a given currency (ask price) and what you are willing to pay for the same as a trader (bid price) is called the bid ask spread. In a nutshell, spread is the numerical variation between the sale and the purchase rates of a quoted currency pair.
How does bid-ask spread work in forex trading?
In currency trading, a market maker creates an online platform where sellers and buyers meet and transact. The bid-ask price is the transactional cost charged by market makers for their service. The forex market works on the principle of demand. When buyers outnumber the sellers, the bid price goes up. This prompts market makers to execute a sale and rake in profits from the transactions. If the sellers exceed the buyers though, ask price remains higher than bid price and sellers may opt to hold on their currency pairs as selling may result to losses.
How forex traders benefit from bid-ask spreads.
Essentially, the spreads-also known as pips-is the market makers charges for providing a currency trading platform. Essentially, high spreads means increased transactional cost on the part of the trader. To make realize larger profits, you should only choose brokers who offer the lowest spreads in addition to the essential trading tools.
The bid-ask price is a determinant factor on how much profits a forex trader locks in. What many people don't actually understand is that the larger spreads, the lower the profits realized. Don't let the broker's marketing jig confuse you. Embrace the information in this article and you are certainly versed to be a better forex trader.