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

Question

Which way would you expect levels of supply and demand to push prices in these scenarios?

A company releases poor annual results

• a Share price rises
• b Share price falls

Reveal answer

Which way would you expect levels of supply and demand to push prices in these scenarios?

Political instability in an oil-producing region threatens supply

• a Price of oil rises
• b Price of oil falls

Reveal answer

Which way would you expect levels of supply and demand to push prices in these scenarios?

The Japanese government announces policies designed to depreciate the yen

• a USD/JPY price rises
• b USD/JPY price falls

Reveal answer

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.

Question

Let’s say you feel the euro is set to strengthen against the dollar, so you decide to buy EUR/USD. Your broker quotes a bid price of 1.23546 and an ask price of 1.23554. Which price will apply for your trade?

• a 1.23546
• b 1.23554

Reveal answer

The spread

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.