How does trading work?
Buying and selling
As the saying goes, 'it takes two sides to make a market'. The two sides concerned are:
- Buyers, who usually believe an asset's value is likely to rise - known as 'bulls'
- Sellers, who generally think an asset's value is set to fall - known as 'bears'
The relationship between them powers the movements in market prices. Let's look at how that works.
Suppose you were buying a car – you'd look for the lowest price on the model you wanted. And if other buyers were thin on the ground you might strike a good deal. On the other hand, if you were trying to bag a rare and sought-after vehicle, you might have to pay the seller a high price.
In the same way, the balance of demand from buyers and supply from sellers influences prices in financial markets.
How levels of supply and demand move prices
IncorrectDisappointing figures will probably make the share unattractive to investors. The resulting selloff will increase supply, causing the price to slump.
IncorrectFears of a shortage of oil to meet world demand are likely to drive up the commodity's price.
IncorrectThe yen will tend to become less attractive to investors, increasing relative demand for the dollar and lifting the price of the USD/JPY pair.
Bid and ask prices
When you look at a quote for a financial asset, you'll generally see not one but two prices:
- Bid price - the price you'll receive as a seller
- Ask price - the price you'll pay as a buyer
The ask price is also known as the 'offer price'.
In a quote, the lower figure shown is normally the bid price and the higher is the ask price.
IncorrectYou'll buy at the ask price of 1.23554. Put another way, you'll pay $1.23554 for each euro you buy. Meanwhile, sellers will receive $1.23546 in return for each euro they trade.
So why do different prices apply for buyers and sellers?
The gap between the bid and ask prices occurs because buyers and sellers often have contrasting views about the value of an asset:
- The bid price is the highest price at which a buyer is prepared to buy
- The ask price is the lowest price for which a seller is willing to sell
The difference between the two prices is known as the 'spread', and also as the 'bid-ask spread' or 'bid-offer spread'.
The spread may also incorporate a broker's fee for handling the trade. The broker quotes clients a price slightly lower than the fundamental bid price or slightly higher than the ask price, keeping the difference to cover its costs.
- The balance between supply (sellers) and demand (buyers) drives price movements in the financial markets
- The bid price is the price you'll receive as a seller, while the ask price (or offer price) is the price you'll pay as a buyer
- The gap between the bid and ask prices is called the spread, and occurs because buyers and sellers often have differing views about the value of an asset