It is the start of another trading day and an FX dealer (market maker) has already decided on their strategy for the day. Because of some economic indicators that are due, the trader believes that there will be a change in the current Australian dollar against Japanese yen rate of AUD/JPY 95.5109/5706. The trader wants to buy the currency it thinks will strengthen. In order to create liquidity in the market, the trader adopts a technique called shading the price.
Let’s look at two possibilities.
1. Shading the Bid
The market maker thinks AUD will strengthen. It therefore wants to increase the bid rates in order to attract price takers. A higher bid means the market maker is purchasing the base currency (AUD) at a higher price in terms of the variable currency.
The market marker makes its bid at AUD/JPY 95.5345 which is higher than the current market bid of 95.5109. Traders (price takers) would naturally prefer to sell AUD at this higher price and more liquidity in AUD comes into the market. This technique is called shading the price and this increases the possibility of the market maker’s aim of being long in dollars.