What Is the Bid and Ask in Forex and How Does It Impact Trading?

Forex trading involves buying one currency while selling another. The difference between the price traders are willing to buy (bid) and sell (ask) a currency pair determines transaction costs. This gap, known as the spread, affects profitability and fluctuates with market conditions.

Understanding bid and ask prices helps traders anticipate costs, manage risk, and make informed decisions.

Distinguishing the Bid from the Ask

Every forex trade involves two prices: the bid and the ask. The bid is the highest price a buyer is willing to pay, while the ask is the lowest price a seller will accept. These prices shift constantly based on supply and demand.

The bid price is always lower than the ask price, creating a spread that traders must account for when entering and exiting positions. For example, if EUR/USD has a bid price of 1.1050 and an ask price of 1.1052, a trader selling euros would receive 1.1050 per euro, while a buyer would pay 1.1052. This two-pip difference represents the cost of executing the trade.

Market participants, including banks, hedge funds, and retail traders, influence bid and ask prices through their orders. Large institutions placing significant buy or sell orders can shift prices based on liquidity and sentiment. When demand for a currency rises, bid prices increase as buyers compete, while ask prices adjust accordingly. When selling pressure dominates, bid prices decline, and ask prices follow.

Determining the Spread on Currency Pairs

Several factors determine the spread on a currency pair, with market liquidity and broker pricing models playing key roles. In highly liquid markets with substantial trading volume, spreads tend to be narrower because buyers and sellers match orders efficiently. In less active markets, where fewer participants place orders, spreads widen as brokers account for the increased difficulty in executing trades at stable prices.

Retail forex brokers offer fixed and variable spreads. Fixed spreads remain constant regardless of market conditions, providing predictable transaction costs. This model is common in dealing desk brokers, who act as counterparties to trades. Variable spreads fluctuate based on trading session activity and economic events. These are more common in ECN brokers, where prices come from multiple liquidity providers and reflect real-time market conditions.

The time of day also affects spread size. During major trading sessions, such as the London and New York overlap, spreads tend to be tighter due to increased institutional participation. In contrast, during off-peak hours, such as late in the Asian session, spreads widen as market activity slows. Economic releases, central bank announcements, and geopolitical events can also cause temporary spread expansions as volatility increases and traders adjust their positions.

Why Spreads Vary Between High and Low Liquidity Pairs

Currency pairs with high liquidity, such as EUR/USD or USD/JPY, tend to have smaller spreads due to high transaction volume. These pairs are heavily traded by institutions, corporations, and individuals, ensuring a steady flow of buy and sell orders. This activity allows market makers and liquidity providers to quote prices with minimal differences between the bid and ask, reducing costs for traders.

Less liquid pairs, such as USD/TRY or EUR/ZAR, experience wider spreads. These pairs attract fewer participants, leading to irregular price movements and greater risk for brokers facilitating trades. To compensate, liquidity providers increase the spread, ensuring they are covered in case of sudden price swings or difficulty in matching orders.

Beyond trading volume, the number of financial institutions quoting prices for a currency pair influences its spread. Major pairs benefit from multiple banks and market makers competing to offer the best rates, keeping spreads tight. Exotic pairs may rely on fewer liquidity providers, reducing competition and resulting in less favorable pricing. Central bank policies and capital controls in certain countries can also restrict a currency’s availability in global markets, further widening spreads.

The Influence of Volatility on Spread Size

Market volatility impacts the spread, as rapid price fluctuations create uncertainty for liquidity providers. When exchange rates shift unpredictably, the risk of executing a trade at an unfavorable price increases. To mitigate this exposure, brokers and market makers widen spreads, ensuring they are compensated for potential slippage or price gaps. This effect is most pronounced during major economic announcements, such as interest rate decisions or employment reports, where sudden surges in buying or selling pressure can lead to sharp price swings.

Periods of extreme volatility can also trigger temporary liquidity shortages, further widening spreads. When price movements become erratic, some market participants withdraw from trading, reducing the number of available counterparties. This thinning liquidity forces brokers to adjust pricing models, making it more expensive for traders to enter or exit positions. Algorithmic trading systems, which react instantly to market changes, can amplify these conditions by executing large orders in milliseconds, creating rapid fluctuations in bid-ask spreads.

Calculating the Effect on Trade Outcomes

The bid-ask spread directly influences trade profitability, as traders must overcome this cost before realizing a gain. Since every position is opened at the ask price and closed at the bid price (for buy trades) or opened at the bid price and closed at the ask price (for sell trades), the spread represents an immediate expense. This impact is more pronounced for short-term strategies, such as scalping or day trading, where frequent trades mean repeated exposure to spread costs.

For example, if a trader buys GBP/USD at an ask price of 1.2752 and the bid price is 1.2750, the two-pip spread means the trade starts at a slight loss. If the price moves in the trader’s favor to 1.2780/1.2778, closing the position at the bid price of 1.2778 results in a 26-pip gain (1.2778 – 1.2752), but the initial spread cost reduces the net profit. Traders using high-frequency strategies must assess whether the potential price movement justifies the cost of entering and exiting trades.

Longer-term traders, such as swing or position traders, experience a less significant impact from spreads, as their trades aim for larger price movements that can absorb the cost. However, during periods of low liquidity or heightened volatility, spreads can unexpectedly widen, increasing the cost of trade execution. This is particularly relevant when setting stop-loss and take-profit levels, as wider spreads can lead to premature trade closures or reduced profit margins. Managing these risks involves selecting optimal trading hours, choosing currency pairs with stable spreads, and using limit orders to control entry and exit points.