Buy/Sell Rates and Spreads
Till now by the consideration of quotations, for simplification of understanding of the website material, we intentionally used only current (spot) exchange rates on Forex. Actually any quotation on Forex has two rates (two prices) – buy rate (bid) and sell rate (ask). These rates usually denoted through slash «/» where before the line the buy rate is indicated, and after line – sell rate, for example USD/JPY 104.75/104.85.
The buy rate is price on which the party, exposed the quotation, agrees to buy from you base currency. The sale rate is price on which the party, exposed the quotation, agrees to sell you base currency. That is concepts of buy and sale in relation to you are "inverted". Buy and sell in this formulation not you, and the party offering to you the rate. In other words, if you are going to buy base currency of the rate, it is necessary for you to look at the sell price (ask). If you are going to sell base currency of the rate it is necessary for you to look at the buy price (bid).
For example, if you are going to get 100 US dollars for the Japanese Yens at a rate USD/JPY 104.75/104.85 you need 100 x 104.85 = 10 485 Japanese Yens. If you are going to get the Japanese Yens by selling 100 US dollars, you receive 100 x 104.75 = 10 475 Japanese Yens.
Depending on the trading platform, provided to the clients by Internet brokers for work, graphic representation of rates will differ. As the big figure rarely change, in a sell rate (ask) of official quotations on Forex they often are not displayed. For example, mentioned above the US dollar quotation to the Japanese Yen can look as USD/JPY 104.75/85. The term big figure on a dealer slang means base number in 100 points, therefore in a sell rate (ask) quotations, as a rule, are displayed only 2 last positions.
The difference between the bid and ask prices (right and left sides of rate) is called spread. The spread forms a basis of profit reception for the party exposing the quotation.
Let us consider exchange office with the typical quotation for Forex of US dollar to the Japanese Yen USD/JPY 104.75/85 with a spread in 10 points. You sell 100 US dollars and receive 100 x 104.75 = 10 475 Japanese Yens. If somebody another comes now and will buy in exchange office these 100 US dollars he will be compelled to pay 100 x 104.85 = 10 485 Japanese Yens. Thus, the exchange office will earn 10 485 – 10 475 = 10 Japanese Yens. Apparently from an example, the exchange office earns on opposite transactions with currency i.e. when someone buys, and someone sells. This principle underlies in reception by broker houses of profit on the Forex market.
Profit in 10 Japanese Yens (approximately 10 cents in recalculation for US dollars) is insignificant small in comparison with a sum of transaction in 100 US dollars. For this reason, exchange offices use a much bigger spread, than in quotations on Forex where the minimum size of deal bigger and makes an order of 100 000 US dollars. More real for exchange office quotation would be USD/JPY 102.00/108.00 with a spread in 600 points. Then the profit on the transaction in 100 US dollars would be 600 Japanese Yens (or 5.56 US dollars in recalculation under the same quotation).
We will learn to define profit on the executed deal and to recalculate it in currency interesting us in following chapters of the website. Now it is important to understand that in any quotation on Forex two rates (buy rate and sell rate) are presented, and that the difference between these rates is called spread and is expressed in points.
So, spread – a source of the income for the party exposing the quotation. For this reason, the retail broker houses representing to private investors possibility to work on Forex through the Internet, as a rule do not take the commissions on transactions – they earn on a spread.
In the subsequent chapters of the website when we will learn to open and close positions on Forex, it will be in detail described why the big spread is not favorable for the private investor. For now it is necessary to understand that at a choice of the Internet broker first of all it is necessary to pay attention to the spread size they offers – the less spread, the better!
Where are buy and sell rates from? Who fixes them? Quotations of currencies are assigned solely by a supply and demand of currencies on the international currency market. The main influence on exchange rates exerts major active participants of the Forex market (about classification of participants on the Forex market was told earlier in the corresponding chapter). Carrying on the main change of current rate, major passive participants and millions of small participants also influence the further change of courses. Thus, if the majority of participants try to sell particular currency the price for it falls. If the main tendency goes to buy of this currency the price for it grows. Thus, the goal of the trader is to distinguish this tendency in time.
For different participants of international currency market at different time the spread size in the quotation is not identical. For the major participants of Forex, making the deals on millions of US dollars, spread size is minimum and amount to, as a rule, just few points as even the small spread in such transactions can make notable profit. For the small Forex participants, making the deals with the smaller sums, the spread size is bigger. So, in exchange offices the size of a spread can reach hundreds points.
In the conditions of unstable, fast changing course, the size of spread may increase. So, during the flurry moments of buy or sell of the currency, caused by publication of the important economic indicator.
The size of a spread can depend on liquidity of the separately taken currency market. If the currency does not trade actively on Forex, the spread under corresponding quotations can be bigger. It is especially for an interbank currency exchange when banks exchange "exotic" low liquid currencies of underdeveloped countries. Private investors basically work on Forex with quotations of high liquid currencies.
For major participants of the international currency market the spread size can depend on a sum of deal. If the sum strongly differs from mid-market sums on particularly taken currency the spread can be bigger. All big deals subject bank to considerable risks whereas for the smaller sums bank expenses on their carrying out increase.
Finally relations between contractors of the deal can influence the size of a spread. If there are strong business relations between the deal parties, they may come to the agreement on decrease of the spread size. And on the contrary, if the dealer of bank does not wish to perform operation with separately taken contractor, it can intentionally overestimate spread size in the quotation, obviously forcing the contractor to refuse the conducting of the operation.
So, a buy rate (bid), a sell rate (ask) and the size of spread in the quotation – key concepts at work on Forex. It is necessary for private investor to understand their meaning distinctly. At work on Forex decisions should be accepted quickly, and for this purpose problems in understanding of basic concepts should not be!
The private investor should not be frightened by the fact, that transactions on Forex, as a rule, consist on hundred thousand and even millions US dollars. The principle of marginal trade, it will be described in the next chapters, allows private investors to make deals for the sums of hundreds times exceeding means they have.