Factor Forex Spread into Trades: A Guide to Bid & Ask PricesHave you ever found yourself in a situation where trade was closed out before reaching your intended stop loss level, or where the market reaches your profit target but the trade never closes in your favour?
It can be frustrating and confusing, leaving you wondering what went wrong. You may even start to blame your broker or the market itself, thinking they are conspiring against you. But the truth is, it's not the market or your broker - it's you.
The key issue is that you're not taking the market spread into account when setting your trade levels. A professional trader must always factor in the spread to avoid inconsistencies and mishaps in their trades. In this post, we will discuss the difference between the BID and ASK price, understand what the market spread is and show you how to factor it into your trade levels for a smoother and more successful trading experience.
As a professional trader, it is crucial to understand the BID and ASK prices. Failure to do so can result in costly mistakes when setting up trades. When placing a trade, these two prices are crucial to consider.
The BID Price
The BID price is something that every trader should have a good understanding of.
The BID price is the price that is displayed on the charts, for example, if the USD/JPY pair was displaying 110.00 on your chart, then the BID price is 110.00.
The BID price is the price that you deal with every time you press the sell button. This is because it is the price at which your broker is willing to purchase the currency from you. In other words, you are selling the currency to your broker at the BID price.
The ASK Price
The ASK price can be a little more complex, as it is often the cause of unexpected outcomes in trade orders.
Typically, you do not see the ASK price when you have your charts open, it is only visible when you open your trade order window or enable that option in your trading software.
The ASK price is the price at which your broker is willing to sell you the currency, and it is a completely different price than what you see on the charts. The ASK price is what you deal with every time the BUY button is pressed and it is typically more expensive than the BID price you are viewing on the chart.
Therefore, the ASK price is the price your broker is "asking" for to sell the currency. The BID price may be 1.45000 on the charts but your broker's ASK price may be something like 1.45030. This is where the concept of calculated Forex spread comes into play.
How to Incorporate Spread into Trade Planning
When placing trade orders, it is important to remember two key principles. These principles must be applied every time you enter and exit a trade, so it is essential to memorize them or keep them in a visible place for reference.
~ When going long, the market is entered at the ASK price and exited at the BID price.
~ When going short, the market is entered at the BID price and exited at the ASK price.
For instance, let's say you want to set a pending order to go long when USD/CAD reaches 1.30000 on the chart, you don’t simply place the pending order entry price at 1.30000. Remember the rule for long trades, you ‘enter the market at the ASK price because the ASK price is what your broker is willing to sell you the currency for. Whenever you are the buyer – the ASK price is quoted.
If your broker's spread is roughly 2 pips for USD/CAD, when the market reaches 1.30000 your broker will be "asking" for 1.30020.
So when the price on the chart reaches 1.30000 (this is the BID price), your broker will be willing to sell the currency for 1.30020 (when the spread is 2 pips).
Therefore, if you place your pending order with an entry price of 1.30000, your trade will not be triggered because your broker is not willing to sell you the currency for that price at that point in time. In this case, you would have to wait for the BID price to reach 1.29980, at which point the broker's ASK price would be 1.30000 and your trade will be filled.
In order to ensure that the trade is triggered when the BID price reaches 1.30000, you must factor in the market spread and set your entry order at 1.30020.
Determining Stop Loss and Exit Prices for Long Positions
Determining stop loss and exit levels for long positions is made relatively simple by utilizing the BID price. The BID price, which is the price at which your broker is willing to buy the currency back from you, reflects the prices that are commonly obtainable from the Interbank Market.
When exiting a trade, the currency is sold back to the broker at the BID price. The BID price is the one that is visible on the charts, and there is no additional commission to be taken into account. Therefore, stop and target levels can be set directly off the BID prices displayed on the charts, making the process straightforward.
Setting Up Short Trades
When executing short trades, the process is reversed. Short trades are entered at the BID price, so the price displayed on the chart is used for the short entry order.
However, the stop loss and target prices for short trades must take into account the Forex spread, as the trade will be exited at the ASK price, which is typically higher than the BID price due to the broker's commission.
To ensure that stop loss levels are not triggered prematurely, the Forex spread must be calculated and added to the stop loss value. This will allow the trade to move freely to its stop-loss level before being closed.
Additionally, the Forex spread must also be factored in for the target price levels of short trades. The target price should be found on the chart, the spread added, and that value should be used as the target price level for every short trade order.
By following the proper procedures for calculating and factoring in the Forex spread, you can now confidently place trade orders and enter the Forex market in an effective manner. This will prevent frustration and disappointment by ensuring that pending orders are executed correctly and that trades exit at the intended price levels.
