Foreign exchange (forex) trading involves buying and selling different currencies in pairs. When you place a trade, you buy or sell a currency pair at a specific price. This price is known as the bid price.
Understanding bid price is crucial for forex traders. The bid price heavily impacts your profit and loss. Knowing how to use bid price strategically can give you an edge in trading.
What is Bid Price in Forex Trading?
In forex trading, the bid price is the price at which a forex trader can sell a currency pair. It is the price at which the market is willing to buy the base currency in exchange for the quote currency.
For example, if the EUR/USD bid price is 1.1200, it means you can sell 1 euro and get 1.1200 US dollars in return. The bid price indicates how much of the quote currency you get for selling 1 unit of the base currency.
The bid price is essentially the demand for the base currency of a currency pair. It represents how much the market will pay for the base currency at a given moment.
How Bid Price is Set in Forex
So how does the forex market determine the bid price for a currency pair? What factors affect a bid price at any given time?
The bid price is largely dependent on the forces of supply and demand. Let’s break this down:
Buyers and sellers: The forex market consists of traders across the globe who buy and sell currencies 24/5. The bid price emerges as an outcome of the ongoing transactions between buyers and sellers in the marketplace.
Liquidity providers: Major banks and financial institutions act as liquidity providers or market makers. They quote bid and ask prices on currency pairs to facilitate trading. The prices they set are based on forex rates in the interbank market.
Interbank rates: The wholesale forex market or interbank market refers to trade between large banks. Interbank rates form the basis for retail forex brokers and dealers to quote prices to traders.
So in essence, the interbank rates filtered down by liquidity providers eventually determine the bid price you see on your forex trading platform. Any shifts in interbank rates get reflected in real-time bid prices.
How to Calculate Profit or Loss Based on Bid Price
One of the main uses of understanding bid price is to calculate your profit or loss on trades. Here is a step-by-step example:
- You buy EUR/USD at the ask price of 1.1200 (you are long EUR/USD)
- The EUR/USD bid price increases to 1.1250
- You decide to close the trade and take profit
- You sell your EUR/USD position at the new bid price of 1.1250
- To calculate profit, subtract your entry price from the exit price:
Profit = Exit price – Entry price Profit = 1.1250 – 1.1200 Profit = 0.0050
- Since 1 pip of a standard lot is $10, your total profit is $50 (0.0050 x $10 per pip x 1 standard lot)
This quick calculation shows how the bid price directly impacts your profit or loss on a trade. Always use the current live bid price to determine your unrealized or realized profit/loss on open or closed trades.
How to Use Bid Price in Forex Trading Strategies
The bid price has many strategic uses in trading beyond calculating profit and loss. Here are some examples:
Place entry orders at the bid: Bid price offers support. Place buy limit orders at or slightly above the current bid to get into trades. The market is more likely to bounce off the bid.
Use bid for conservative target exit: Aim for bid price exit when you want to take a conservative profit. The bid represents the maximum price you can sell for. Exiting at the bid guarantees locking in profit.
Monitor price action at the bid: Watch for candlestick patterns like pin bars and engulfing patterns to form at the bid. This suggests potential reversal. You can enter trades in the opposite direction.
Scale into winning trades at the bid: Add to winning positions at the bid price as it rises. This allows you to benefit from emerging uptrends.
Use stop losses just below the bid: Place stops just below the bid to allow some flexibility in your trades before getting stopped out. The bid acts as nearest support.
Factors That Influence Bid Prices in Forex
Many interconnected factors can cause the bid price on currency pairs to shift up or down. Being aware of these dynamics allows you to understand moves in real-time rates. Here are the key factors:
- Economic data releases: News around GDP, employment, manufacturing, interest rates, and inflation greatly impact currency valuation and interbank rates. This filters down to retail bid prices.
- Monetary policy: Central bank decisions on interest rates and other monetary policies affect the supply and demand for currencies. Quantitative easing, for instance, devalues and lowers the bid price for a currency.
- Geo-political events: Wars, elections, unrest, and political instability influence currency and asset flows, risk sentiment, and trade flows. These eventually impact the currency bid prices.
- Market sentiment: Prevailing optimism or risk aversion among investors moves capital flows between assets. Risk-on sentiment lifts bid prices of riskier currencies, while risk-off drives bid prices of safe-haven currencies.
- Economic performance: The health, growth forecasts, and outlook for countries drive demand for their currencies. Strong economic data lifts currency bid prices while weak data pressures them lower.
- Technical price levels: Support and resistance levels based on historical price action influence trader behaviour. Technical milestones like 50-day moving averages provide bounce levels for bid prices.
Frequently Asked Questions About Bid Price in Forex
Here are some common questions traders have about understanding and using bid price:
What’s the difference between bid and ask price?
The bid price is the price at which you can sell a currency pair. The ask price is the price you can buy a currency pair at. The ask will always be slightly above the bid due to the spread between the two prices.
How is bid price different from the last price?
The last traded price is simply the last price at which a currency pair traded at. The bid price is the current price buyers are willing to purchase at. The last price can match the bid, but often differs.
Why do bid prices change so frequently?
Bid prices fluctuate based on the ongoing supply and demand dynamics in the forex interbank market. Changing economic conditions, news events, and trader positions lead liquidity providers to update rates, which alters the bid price.
Is there only one bid price at a given time?
Each liquidity provider may have slightly different bid prices for the same pair at the same time. But the bid you see on your broker platform represents the industry average bid price from their pool of liquidity providers.
When should I use the bid price over the ask or last price?
Use the bid when you want to exit/take profit conservatively or when you want to determine potential support levels on a pair. Refer to ask for entries and last price for less precision.
Conclusion
Understanding bid prices is a vital skill in forex trading. Mastering the use of bid prices in calculations, setting trades, and analyzing market dynamics can give you an edge.
To recap, the bid represents the price you can sell a currency pair at based on current market demand. You enter trades at the ask but exit at the bid. Always reference the live bid price when taking profit to accurately calculate your trades.
The bid forms the closest level of support. Monitor price action at the bid for reversal signals. Place entry orders just above the bid to benefit from potential bounces. Use the knowledge of all the factors that move bid prices to make informed trading decisions.
So take the time to actively study the bid price in your forex trading. Bidding adieu to any confusion around bid prices will make you a better, more profitable forex trader.
