Bid, Ask, Spread – what they are, and how they need to be factored into your calculations
My take profit was hit, why wasn’t my position liquidated?
I ran into what appeared to be a strange issue the other day – as you’ll know if you’ve been reading, all of my trades are pending orders with the stop loss and take profit fixed on entry. So one of my sell orders was triggered, price headed to my take profit, appeared to overshoot it by about 3.5 pips before heading back. My take profit wasn’t triggered, I was still in the trade, and price headed dangerously towards my stop loss. In this case the loss wasn’t triggered, and price went on to hit my take profit. I wasn’t actually sure what could cause this to happen (I thought maybe something to do with being on a demo feed), so I checked with my broker to find out as I’m only trading demo currently, I was a bit concerned about this sort of thing happening on a live account.
Aah, it’s because of the bid and the ask prices…
The explanation was that it was to do with the bid and the ask, it’s pretty obvious, and I really should have thought about this before. I remember reading that you paid the spread when you entered the trade, so kind of ignored the spread issue from then on. Just goes to show don’t trust stuff you read on the net on face value, find out for yourself!
Anyway, how it works is that there are always two prices – a buy price (ask), and a sell price (bid). These prices are actually the nearest pending orders on the market. The difference between the ask and the bid is the spread. Everyone who’s spent more than an hour looking into forex knows what the spread is – it is essentially the cost of any trade.
Now, when you go long, you buy at the ask, and when you go short, you sell at the bid.
However, when you liquidate a long position, you’re essentially selling, so you liquidate at the bid price, and conversely when you liquidate a short position, you’re buying, so you liquidate at the ask price.
The reason this caused me problems is that my platform – MetaTrader – only displays one price (so say to remove complexity, though that means it’s not showing you the true story) – the bid price.
This can make short positions confusing.
Now for long positions, you open the position at the ask, and liquidate at the bid, since metatrader just displays the bid, the price displayed is the price at which you’ll liquidate, so there’s no real confusion about what’s going on – the spread is essentially paid when you enter the trade.
It gets less clear when you’re dealing with a short position – you open the position at the bid, and close at the invisible ask. This means that the price that will trigger your stop loss or take profit on a short position is not displayed on your chart.
(In this case the spread is paid when you close a short position, and since spread is variable on most accounts, you can never know how much you’ll pay for your position, but let’s not go there right now. )
Stop losses will be triggered before price reaches your stop.
Take profits will be triggered after price crosses your TP.
So what do you need to do about this?
Well, the most obvious thing is to be aware of the spread whenever you open a short position, and factor that into your calculations.
Since I discovered this, I always add the current spread to my stop loss, and my take profit for every short position I open.