What are the bid and offer price?January 25, 2021 2021-01-25 20:31
What are the bid and offer price?
Trying to understand what the bid and offer price is can be difficult for beginners but it shouldn’t be. It’s simply the price that you either buy at or sell at.
You might have also heard it called the bid and ask price. It’s just the same as the bid and offer prices. It’s just the finance industry adding more jargon to the sector (for no good reason in our opinion).
What is the bid price?
The bid price is the highest price a buyer is willing to pay for the instrument.
When you’re looking at your trading platform, the bid price is the lower price of the two available to you. Why? Because the person/company/market maker you’re trading with is the person buying.
When you sell, the market maker is buying it off of you. That price is the highest they’re willing to buy it from you.
What is the offer price?
The offer price is the lowest price a seller is willing to accept for an instrument.
Again, when you’re looking at your trading platform, the offer price is the higher price of the two available to you. Why? Because the person/company/market maker you’re trading with is the person selling. So they’re selling at the lowest price they’re willing to go.
When you buy, the market maker is selling it to you. The price is the lowest they’re willing to see you that instrument.
How does the bid and offer price work?
The bid and offer prices are prices that the market maker either bid for … or offer. If you’re looking to:
- Buy an instrument from a market maker or a broker or anyone, they will offer you a price, it’s then up to you if you want to buy it.
- Sell an instrument, the market makers will bid for your instrument. You will be shown the best bid from those market makers and it will be shown as the bid price.
When you look at the bid and ask price on your trading platform, it can be confusing that the offer price is the price that you’re buying at and that the bid is where you’re selling. But just remember that there is something else in this transaction and it’s the market maker that creates the price.
Therefore, remember when you’re trading:
- You buy at the offer
- You sell at the bid
Both the bid and offer prices are set by the market maker. The actual prices are determined by supply and demand, and this is why you see the prices move.
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What’s the difference between the bid and offer price?
The difference between the bid and the offer price is called the spread. This is the gap between the two prices and is where the market maker or broker makes their profit.
You’ll notice on your platform that when you sell, you’re selling at the lower price and when you’re buying you buy at the higher price.
That market maker is therefore making a profit in that spread. They are buying at the lower price (bid) and selling at the higher price (offer), that difference is profit for them.
Why do I always enter a trade in the negative?
You will notice that every time you enter a trade, you are in the negative. This is because you have bought at a slightly higher price than the market is. You have bought at the offer price, a fraction above the price of the actual market.
And this is again, the broker or market maker making their profit.
How are the bid and offer affected by price movements?
The bid and offer prices will move with normal supply and demand. If the supply is larger than the demand then the price will go lower and vice versa, if demand exceeds supply, then the price will increase.
But what happens when the market becomes volatile?
When market volatility increases, you do tend to find that the difference between the bid and offer price increases. You may hear this referred to as widening and it simply means that the bid and offer prices are getting further away from each other.
Why do spreads widen?
The spread or the difference between the bid and offer price widens because the market maker or broker is wry of the market volatility and see it as increased risk. With increased risk, they protect themselves by offering high prices for you to buy and lowering their bid prices for you to sell at.
Therefore the gap widens between the two prices.
As mentioned, this is done to protect themselves from any large and unexpected market moves.
Example of the bid and offer price
Let’s have a look at an example of the bid and offer price. If you’re looking to trade the forex market and you want to buy EUR/USD, here is what you might encounter.
- EUR/USD is trading at 1.2100. This is its price
- You want to buy it
- The market maker offers you a price and it is 1.2101 (OFFER PRICE)
- If you wanted to sell it, they would bid to buy it from you at 1.2099 (BID PRICE)
- The difference between the bid and the offer price is 0.0002
- This is the spread and essentially what it will cost you to enter and exit the trade
- You’ve bought EUR/USD at 1.2101
- The market increases to 1.2150
- You decide you want to sell
- The market maker bids to buy it from you at 1.2149 (BID PRICE)
- You sell it to the market maker at that price
- The market has moved 50 pips from 1.2100 to 1.2150
- You have profited 48 pips because of the spread that the market maker charged
- The market maker profited 2 pips from your trade
As you can see, the difference between the bid and the offer price is very important to your bottom line. There is a direct correlation with the size of the spread and how much profit you make from a trade.
If you trade with £10 per pip, you would have made £480 profit in the example above, however, if you were using a broker that had a spread of 6 pips, you would only have profited £440 from the trade.
That is an 8.3% decrease in profit. If you look at that overtime on all your trades, you will notice it can be quite costly. This is why it’s hugely important that you choose your broker wisely and check their spreads.
Bid price and offer price summary
Now you should have a good idea about what the bid and offer price is in trading. You should understand that you as the retail trader will be:
- Buying at the offer price
- Selling at the bid price
You should also see how important it is to choose a broker that can offer you good tight spreads. Where the bid and offer prices are as close together as possible.