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п»їWhat is the Selling Rate and Buying Rate When Trading Currency Exchange Rates?
Published: 6 Sep at 12 PM by Elaine Housten and tagged under category Currency Trading.
A question that crops up time and time again for new entrants to tradingforeign exchange rates is what is the selling rate and buying rate for a currency pair, and why are they different? When you open you're trading terminal you might be confronted with two separate rates for a single currency pair, so what do they mean for us and more importantly, our profit?
Above: Bid, Ask & Spread for Euro to US Dollar Exchange Rate.
In order to understand what the buying and selling rates mean, we need at least a shallow understanding of how currency markets and trading foreign exchange works overall.
What is the Bid Ask Spread?
The concepts here are relatively simple but the terminology employed can often lead to confusion. The buying price for a currency exchange rate, also known as the bid price, can be thought of as the exchange rate at which the MARKET is willing to BUY at. The selling or 'ask' rate is the exchange rate which sellers within the MARKET are willing to SELL at.
Above: Bid Ask Spread In Exchange Rates.
The bid or buying rate is (almost) always lower than the ask or selling rate with the difference between the two known as the spread. There are rare occasions when the buying rate can be lower than the selling rate, offering what's known as an arbitrage opportunity - essentially the ability to buy an asset a lower price than it can be sold for - usually across exchanges. Arbitrage opportunities are relatively rare and with the advent of high frequency trading and a growing presence on algorithmic trading - as opposed to humans placing trades - opportunities to 'arb' are generally restricted to all-but those with the fastest connections - i.e., those co-located in close proximity to a dealing desk.
The bid ask spread principle applies to most trade-able assets, whether you're speculating on currency markets, stocks and equities or commodities and there's a very simple reason why. Profit!
Think of the analogy of buying a new car: if you've just bought it (the cost of the car is the selling or 'ask' price), leave the forecourt and then change your mind, you can bet your bottom dollar that the dealership will offer you less (the buying or 'bid' price) than you just paid moments ago. The spread between the buying and selling rate basically ensures profit for the specialist who has facilitated the trade.
In financial markets, a zero pip spread would allow traders to buy and sell currencies at the exactly the same price. Great in theory but as they say, 'nothing comes for free' and zero spread would eliminate the the ability for brokers to make a profit. With this in mind, the bid-ask spread can be though of as a cost associated with placing a trade.
Consider the example of going long the Euro to US Dollar (EUR/USD) exchange rate, paying the selling or 'ask' price (inflated for illustrative purposes) at $1.1020 while the buying or 'bid' price for Fibre was $1.1025. In order for your trade to get out of the red and into the money, Fibre would have to rise to $1.1025 to just break even.
As a general rule of thumb, the more liquid an asset is, the smaller the bid-ask spread should be - regardless of whether we're talking about currency markets or stocks. EUR/USD is the most liquid currency pair in the world, offering some of the narrowest spreads around (at the time of writing, $1.10212 (bid) versus $1.10214 (ask) although the spread varies markedly from broker to broker. For stocks, Apple is a popular stock with the bid-ask spread on AAPL shares typically around 1p.
To calculate the cost of the spread we can simply find the difference between the big-ask prices, for the real figures above this would be $0.00002 cents, doesn't sound like much right? But consider that the average trade is over one million units of 10,000 EUR/USD then that fraction of a cent cost multiplies to become $20. Using our fake, inflated figures above, with a spread of (1.025 - 1.020) $0.005, the cost of the spread would be $500!
Given that the spread can be considered a cost, it's logical for investors to seek out the narrowest spreads available when making trades. So where does the spread come from and how is it determined? In order to understand that we need to take a step back and have a wider look at how currency markets and exchange rates work in general.
The Interbank Market and Interbank Exchange Rates.
Unlike retail investors speculating on currency markets, big banks and large institutions (essentially the worlds largest commercial liquidity providers) exchange currencies with a much tighter spread. As liquidity is passed down the line to successively smaller and smaller specialists, the spread widens, with each broker tacking on their own fee for facilitating trades.
The interbank rate is also known as the mid-market rate, spot rate or real exchange rate and is exactly half way between the buying and selling rates for a currency pair.
Above: Currency Market Hierarchy.
Knowing that a higher spread between the buying and selling rate equates to higher costs, what can we do without access to interbank markets? In recent years there's been a marked push for narrower spreads - tech-enabled trading means that positions are often open for mere seconds, wherein a hefty spread would wipe out the potential for profit.
The hunt for tighter spreads has spurred a rise in popularity of Straight Through Processing (STP) as well as Electronic Communication Network (or ECN) brokers, both of which operate as No Dealing Desk (NDD) entities - essentially meaning they exist to forward orders to the interbank market without being processed by the dealing desk.
Rather than relying on in-house liquidity to facilitate trades, these NDD brokers exist to match orders with liquidity, often from multiple sources. In the case of STP, orders are forwarded straight to liquidity providers while in the case of ECN, trades are also matched internally between members of the ECN. Another difference is that ECN's tend to charge a fixed commission per trade although for large volume traders, the benefits of narrower spreads outweigh the costs.
Above: STP / ECN Brokers In Currency markets.
Selling and Buying Rates Key Points.
- The buying rate for a currency is known as the 'bid' and reflects what the market is willing to pay for an asset.
- The selling rate is known as the 'ask' and reflects what the markets is willing to sell an asset for.
- The spread between the buying and selling rates is where specialists (brokers) make their profit.
- The buying rate is (almost) always lower than the selling rate, a higher bid than ask represents an arbitrage opportunity.
- As liquidity decreases down the foreign exchange market hierarchy, the spread widens as more specialists add their 'fee' for facilitating trades.
- The spread between the bid and ask prices can be considered a cost, with narrower spreads better than wider spreads.
- Straight Through Processing (STP) brokers aggregate liquidity from a number of sources.
- Electronic Communication Networks (ECN) match orders with liquidity both externally and within the network and usually charge commission per trade.
Bid-Ask Spreads in the Foreign Currency Exchange Market.
The bid-ask spread (informally referred to as the buy-sell spread) is the difference between the price a dealer will buy and sell a currency. However, the spread, or the difference, between the bid and ask price for a currency in the retail market can be large, and may also vary significantly from one dealer to the next.
Understanding how exchange rates are calculated is the first step to understanding the impact of wide spreads in the foreign exchange market. In addition, it is always in your best interest to research the best exchange rate.
Key Takeaways.
The bid-ask spread (or the buy-sell spread) is the difference between the amount a dealer is willing to sell a currency for versus how much they will buy it for. Exchange rates vary by dealer, so it's important to research the best rate before exchanging any currency.
Bid-Ask Spreads in the Retail Forex Market.
The bid price is what the dealer is willing to pay for a currency, while the ask price is the rate at which a dealer will sell the same currency.
For example, Ellen is an American traveler visiting Europe. The cost of purchasing euros at the airport is as follows:
EUR 1 = USD 1.30 / USD 1.40.
The higher price (USD 1.40) is the cost to buy each euro. Ellen wants to buy EUR 5,000, so she would have to pay the dealer USD 7,000.
Suppose also that the next traveler in line has just returned from her European vacation and wants to sell the euros that she has left over. Katelyn has EUR 5,000 to sell. She can sell the euros at the bid price of USD 1.30 (the lower price) and would receive USD 6,500 in exchange for her euros.
Because of the bid-ask spread, the kiosk dealer is able to make a profit of USD 500 from this transaction (the difference between USD 7,000 and USD 6,500).
When faced with a standard bid and ask price for a currency, the higher price is what you would pay to buy the currency and the lower price is what you would receive if you were to sell the currency.
Direct and Indirect Currency Quotes in Forex Markets.
A direct currency quote, also known as a “price quotation,” is one that expresses the price of a unit of foreign currency in terms of the domestic currency. An indirect currency quote, also known as a “volume quotation,” is the opposite of a direct quote. An indirect currency quote expresses the amount of foreign currency per unit of domestic currency.
Most currencies are quoted in direct quote form (for example, USD/JPY, which refers to the amount of Japanese yen per one U.S. dollar). The currency to the left of the slash is called the base currency and the currency to the right of the slash is called, the counter currency, or quoted currency.
Commonwealth Currencies.
Commonwealth currencies such as the British pound and Australian dollar, as well as the euro, are generally quoted in indirect form (for example, GBP/USD and EUR/USD, which refer to the amount of US dollars per one British pound and per one euro).
Consider the Canadian dollar. In Canada, this quotation would take the form of USD 1 = CAD 1.0750. This represents a direct quotation, since it expresses the amount of domestic currency (CAD) per unit of the foreign currency (USD). The indirect form would be the reciprocal of the direct quote, or CAD 1 = USD 0.9302.
Next, consider the British pound. In the United Kingdom, this quotation would take the form of GBP 1= USD 1.700. This represents an indirect quotation since it expresses the amount of foreign currency (USD) per unit of domestic currency (GBP). The direct form of this quote would be USD 1 = GBP 0.5882.
Understanding How Currencies are Quoted.
When dealing with currency exchange rates, it's important to have an understanding of how currencies are quoted.
Suppose there is a Canadian resident who is traveling to Europe and needs euros. The exchange rates in the forex market are approximately USD 1 = CAD 1.0750, and EUR 1 = USD 1.3400. That means the approximate EUR/CAD spot rate would be EUR 1 = CAD 1.4405 (1.3400 x 1.0750). A currency dealer in Canada might quote a rate of EUR 1 = CAD 1.4000 / 1.4800, which means that you would pay 1.48 Canadian dollars to buy one euro and would receive 1.40 Canadian dollars if you sold one euro.
The calculation would be different if both currencies were quoted in direct form. If the approximate spot rate for the Japanese yen is USD 1 = JPY 102, this is how you would calculate the price of yen in Canadian dollars:
USD 1 = CAD 1.0750 and USD 1 = JPY 102.
CAD 1.0750 = JPY 102, or CAD 1 = JPY 94.88 (102 / 1.0750)
In general, dealers in most countries will display exchange rates in direct form, or the amount of domestic currency required to buy one unit of a foreign currency.
How to Calculate Cross-Currency Rates.
When dealing with cross currencies, first establish whether the two currencies in the transaction are generally quoted in direct form or indirect form. If both currencies are quoted in direct form, the approximate cross-currency rate would be calculated by dividing "Currency A" by "Currency B."
If one currency is quoted in direct form and the other in indirect form, the approximate cross-currency rate would be "Currency A" multiplied by "Currency B."
When you calculate a currency rate, you can also establish the spread, or the difference between the bid and ask price for a currency. More importantly, you can determine how large the spread is. If you decide to make the transaction, you can shop around for the best rate.
Exchange Rates Vary by Dealer.
Rates can vary between dealers in the same city. Spending a few minutes online comparing the various exchange rates can potentially save you 0.5% or 1%.
Airport kiosks have the worst exchange rates, with extremely wide bid-ask spreads. It's possible to receive 5% less of the currency you are buying. It may be preferable to carry a small amount of foreign currency for your immediate needs and exchange bigger amounts at banks or dealers in the city.
Some dealers will automatically improve the posted rate for larger amounts, but others may not do so unless you specifically request a rate improvement. If you haven’t had the time to shop around for the best rates, research ahead of time so you have an idea of the spot exchange rate and understand the spread. If the spread is too wide, consider taking your business to another dealer.
The Bottom Line.
Wide spreads are the bane of the retail currency exchange market. However, you can mitigate the impact of these wide spreads by researching the best rates, foregoing airport currency kiosks and asking for better rates for larger amounts.
Is there a difference between buying a currency and selling the currency to be converted to?
I'm not an economist. I'm looking to exchange my CAD to EUR. I watched the rates on a exchange office, and I found something strange:
How can there be 4 different rates? I understand why CAD -> EUR is different of EUR -> CAD with the supply and demand. When the exchange office buys 1 CAD, it sells EUR too. I supposed it was to make things easier, so I checked it:
Here, we found that it's indeed, more interesting for the customer to accept a sell than buying (from the office point of view for the words buy/sell). But is the difference, normal? And why?
2 Answers 2.
Buy and sell rates are different because the currency vendor wants to make a profit and is also taking some risk with the exchange. It is possible that she cannot unload all the CADs they buy from you immediately and then perhaps in the future they will depreciate. (Perhaps they will appreciate. It is uncertain, hence there is risk.)
The same applies to buying and selling euros.
Usually there is some middle rate $x$ EUR/CAD. The vendor will deviate 1-2% from this in the direction favorable to her, depending on the direction of the deal (buying EURs with CAD or the other way around). You can look up something close the middle rate on XE. Currently this is about 1.394 CAD/EUR. Your vendor seems to sell at a premium that seems higher than normal to me, so perhaps see if you can find another currency merchant.
How to Understand Currency Exchange Rates.
Travel Tips.
Related Articles.
How to Exchange Nigerian Money to USA Dollars Argentinian Peso Conversions U.S. Dollar Vs. Indian Rupee Exchange Rate How to Convert British Pounds to U.S. Dollars.
Beware the friendly merchant who offers to take your U.S. cash instead of the local currency. Even if he has good intentions, you can rest assured that he won't be giving you the best possible exchange rate. To detect just how much of a swindle his offer might (or might not) be, and to decode the same information with the many options for exchanging foreign currency, you're going to need to understand how currency exchange rates work.
The Basics of Currency Exchange.
Not all currencies are valued equally – but there's no one central clearinghouse that determines their relative values. Instead, the balance between any two nations' currencies is in constant flux, determined by factors like each nation's inflation, debt, interest rates, political stability and trading agreements. The relative value of any two currencies is expressed as the exchange rate or, to put it another way, how many units of one currency you'd need to buy a unit of the other currency.
Why should exchange rates matter for you when traveling? Easy: The stronger the dollar (or any other home currency) is in relation to the foreign currency, the less you have to spend – in your own currency – on your overseas trip.
Spot vs. Nominal Exchange Rates.
For travelers, there are two types of exchange rates to consider. The first is the spot exchange rate, also called the interbank rate. This is the exchange rate banks give each other when they buy and sell foreign currencies. But this isn't the exchange rate they'll give you, because any institution that exchanges money – be it a bank, a money changer at the airport, or that friendly merchant in his booth – takes a bit of a markup to cover its expenses and profit.
The actual exchange rate you get as a consumer is the nominal exchange rate; this is what most people mean when they say "exchange rate."
Even though you don't get to use the spot or interbank exchange rate, it's still helpful to know it, because then you can tell how good (or bad) a deal any other money exchanger is giving you in relation to that rate. The rates you see on the news, in financial newspapers and even in most search engines will usually be the interbank rates.
Reading Labeled Exchange Rates.
Depending on your source, exchange rates can come in one of two forms. In the first case, each currency is labeled; for example, 1 euro (abbreviated as EUR) might equal 1.2 U.S. dollars (abbreviated USD). That means that every 1 euro has the equivalent spending power of $1.20. In this case, the euro is notably stronger than the dollar. If your home currency is USD, you might see the same relation expressed as 1 USD = .83 EUR, or $1 having the equivalent spending power of .83 euro. In both cases, each currency is labeled, so it's easy to decipher their relative power.
Other Ways of Expressing Exchange Rates.
There isn't always room in a newspaper, or on the rate board at the money changer, to label everything. So you might also see an exchange rate expressed as: EUR/USD = 1.2. This means that one unit of the first currency (in this case, euros) is equal to the specified number of units in the second currency (in this case, U.S. dollars). So 1 euro equals $1.20, just as in the labeled currency example. You might also see a buy rate and a sell rate, which are relative to the local currency. The sell rate represents the rate at which the money changer will sell you a foreign currency – for example, the rate at which a U.S. bank will sell you euros. The buy rate represents the rate at which the money changer will buy foreign currencies back and exchange them into the local currency. So, for example, once your trip is over, a U.S. bank would "buy back" your euros at the buy rate.
Now that you've gone to all the trouble of understanding exchange rates, you may be surprised to know that the best exchange rates almost always come from the ATM machine. So while it makes sense to carry a little cash in case of emergency, you'll almost always get the best rates if you make withdrawals from ATMs as needed, or if you use a credit card to make your purchases. Choose a credit card with no international transaction fees, if possible; if asked, choose to do the transaction in your own local currency – otherwise the merchant's payment processor will tack on an extra conversion fee on top of the exchange rate you're already paying.
Difference between buy and sell rates foreign exchange.
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Exchange rates explained.
As the world's foreign-exchange specialists, we've developed our own handy guide to exchange rates.
The Travelex Online Rate.
At Travelex, we offer you $0 commission and a competitive market exchange rate when you buy foreign currency from us online, whether in cash or our Multi-currency Cash Passport TM card.
These online rates are our exclusive online rate and are not available in-store.
Currency jargon explained.
Foreign exchange can be confusing. To help you make sense of it all, here are some common terms to do with currency:
Sell rate – This is the rate at which we sell foreign currency in exchange for local currency. For example, if you were heading to Europe, you would exchange Australian dollars for euros at the sell rate.
Buy rate – This is the rate at which we buy foreign currency back from you into your local currency. For example, if you were returning from America, we would exchange your US dollars back into Australian dollars at the buy rate. Holiday money rate or tourist rate – This is another term for a sell rate.
Spot rate – This is known more formally as the вЂinterbank’ rate. It’s the rate banks or large financial institutions charge each other when they’re trading significant amounts of foreign currency. Spread – This is the difference between the buy and sell rates offered by a foreign exchange provider.
Cross rate – This is the rate we give to customers who want to exchange currencies that don’t involve the local currency (for example, if you wanted to exchange US dollars into British pounds).
Commission – This is the fee that foreign exchange providers charge for exchanging one currency with another.
Frequently asked questions.
Currencies constantly move up and down against each other because they’re traded on financial markets. Market changes can be caused by supply and demand, as well as by political and economic events.
You can’t predict when exchange rates will go up or down, but our currency converter above will show you historical rates, to give you an idea of how the current conversion rate compares to the past few months or year.
You can convert your dollars into over 45 currencies with Travelex, either online or at 120 stores across Australia. Got another question? Check out the rest of our FAQs.
Travelex Limited (ABN 36 004 179 953, AFSL Number 222444) arranges for and sells Online Foreign Currency via its Online Ordering Facility. You should consider the Online Foreign Currency Product Disclosure Statement and Terms and Conditions before deciding whether to acquire the product.
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