Trading in the forex market is a two-way process. If you can buy a currency pair at a particular price, then there must be someone who is willing to sell it at that price. Only then the transaction can be executed. So bid price is the maximum price that a buyer is willing to pay for a currency pair and ask price is the minimum price at which the seller is willing to sell the currency pair. And the difference between these two prices is called spread. It is crucial to understand bid-ask and spread if you want to enter into forex day trading.
Let me elaborate the things:
Whenever you open your trading platform, you will see the current price of a particular forex pair. This is the last price at which the transaction took place. Now if you want to open a position at that particular price, there is a high probability that you won’t get it even if the price is there only.
This is because there are two parties involved in trading: buyer and seller. So if you are willing to buy a currency pair at a particular price, there has to be a seller selling at that price. Suppose you go to a shopkeeper and want to purchase a pair of shoes. Now the shopkeeper quotes a price of say $40 (ask price), but you think that the shoes should be of $35 (bid price) and you start bargaining. Now, if the shopkeeper accepts your bid, he will sell the shoes, and if you accept the shopkeeper’s rate, then you will buy the shoes. Or you both can come to a final price by lowering or upping the rate.
Every investment is of two types: long term and short term (usually day trading in the case of forex). Bid-ask and spread are used in the day trading. In the exchange, there are bidders who are willing to buy, and there are askers who are willing to sell their currency pair. While doing day trading, the sellers put forth their currency pair at a particular price to sell, and the bidders place a bid at some specific price to buy. If the order does not execute for a long time, the sellers try to reduce the rate a bit, and the bidders try to increase the rate to make the orders execute. But finally, it executes only when ask and bid price matches.
So if you want to buy a currency, then you will click the bid button, and if you want to sell that currency, you will click ask or offer button.
The liquidity of any currency pair can be analyzed using the value of spread as these two are inversely proportional which means smaller the spread, more liquid is the currency pair and vice versa.
A spread can be large or small which depends on many factors such as volume, currency pair price, etc. Currencies with a very high price have a wider spread and those with a low price have narrower spread.
You may see that sometimes brokers may use the term bid and offer. This is same as bid and ask.
Suppose you have selected the currency pair EUR/USD and the rate is 1.2000. This means if you buy 1 Euro and pay in dollars, you have to pay $1.2000.
Now, suppose you place a bid at $1.1900 which means you are willing to buy 1 EUR at $1.1900 and there is a seller who is willing to sell it at $1.2000. If this keeps on happening and no seller or buyer is ready to be flexible, then there is no chance that the order can get executed.
But if the seller is willing to reduce the ask price or the buyer stands ready to increase the bid or both just increase and decrease the bid then there is a high chance that the order can get executed.
It happens in very few cases that the order never executes throughout the day as there is not only one bidder or one seller. There could be hundreds of bidders and sellers, so the price usually matches.