The Spread

As with other financial instruments, there is a price an investor can sell at which is called "bid" price, and a price the investor can buy at which is called "ask" price.

From the broker-dealers' perspective, the bid is the price at which the broker-dealer is prepared to buy, therefore to "bid" a specific currency pair from you as a trader. At this price, you can sell the base currency to the broker-dealer.

For example, in the quote EUR/USD 1.2872/73, the bid price is 1.2872. This means you sell one Euro for 1.2872 US Dollars.

In turn, the ask is the price at which the broker-dealer is prepared to sell (is "asking" for) you a specific currency pair. At this price, you can buy the base currency. It is shown at the right side of the quotation. Sometimes it's also called the "offer" price.

Using the same EUR/USD quote, the ask price is 1.2873. This means you can buy one EUR for 1.2873 US Dollars. The ask price is also called the offer price.

The difference between both prices is known as the "bid-offer spread" or "the spread", and it's expressed with a similar quote convention than the pair:

Bid / Ask

In our example, the spread value would be of 1 point, the difference between 1,2873 (the price the broker-dealer is ready to sell) and 1,2872 (the price the broker-dealer is ready to buy at).

So to summarize:

Example: EUR/USD 1.2872/73

Ask Price: 1.2873

Bid Price: 1.2872

Spread: 1 point

Another example illustrates that the bid price of the AUDUSD pair is 0,6520 USD and the offer price is 0.6528 USD:

AUD/USD = 0.6520/28

The critical characteristic of the bid/ask spread is that it is also the transaction cost for a round-turn trade.

The formula for calculating the transaction cost is:

Transaction cost = Ask Price – Bid Price

The spread in this case is made of 8 points, also called "pips".

The spread is usually lower in the majors, since a high turnover assures ample liquidity to meet the trading needs. That is why interbank and retail dealers charge less for the majors through the spread. For less traded pairs or cross currency pairs the spread will be bigger, since at an interbank level these trades may involve the use of synthetic pairing and dealers have to assume more risk in completing those transactions.