Spread in the world of forex trading isn’t a mystery. Where currency pairs are exchanged around the clock, one of the essential concepts traders need to grasp is the spread. The spread is the difference between the bid and the ask price. Understanding how spreads work helps traders navigate the forex market better, manage risk more effectively, and make informed decisions. With the rise of online forex trading platforms, being mindful of spreads has become very important to ensure a successful and cost-effective currency exchange strategy. This article delves into every detail of a spread in forex trading.
What is a Spread in Forex Trading?
In forex trading, the spread is the representation of the difference between the bid and ask price. The Bid is the maximum price that a buyer is offering to pay for a currency pair or simply it is the highest price that buyers would pay at a given moment.
The Ask price, also known as the offer price, represents the minimum price that a seller is willing to accept for a currency pair at a given moment.
For example, if for EUR/USD the bid price is 1.12350 and the ask price is 1.12355, the bid-ask spread is 0.5 pips (5 pipets). This means that buyers are willing to purchase 1 Euro for 1.12350 US dollars or that sellers are willing to sell 1 Euro for 1.12355 US dollars.
What is a Pip Spread in Forex?
Pip is short for percentage in point or price in interest, which is usually the main unit of measuring the spread and price moves that a currency pair can make based on the movements of the market. A pip is the fourth decimal place for most currency pairs. For instance, in the EUR/USD pair, a movement from 1.11500 to 1.11510 shows a 1-pip movement. For currency pairs involving the Japanese yen, a pip is the second decimal place, e.g. USD/JPY pair’s movement from 110.500 to 110.510 represents a 1-pip move.
The value of a pip can vary based on the spread between different currency pairs and the size of the trade but usually, for standard lot in major pairs, a pip change can equate to $10. However, this is based on a standard lot size of 100,000 units.
What are Types of Spreas in Forex?
Spread in forex can vary based on the brokerage firm a trader is dealing with but primarily there are three types of forex spread.
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Fixed Spread
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Floating Spread
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Commission-Based Spread (zero spread)
Fixed Spread: A fixed spread remains constant regardless of the market change, meaning that despite all the conditions in the current market, whether it is volatile or not, the spread between currency pairs remains the same. This is because brokers behave as the counterparty towards their traders. Implementing a dealing desk method allows brokers to buy a large position from their liquidity providers and offer it to individual traders in smaller sizes.
Advantages: A fixed spread is highly advisable for new traders or traders with smaller accounts since its biggest advantage is that costs are exceptionally predictable, which helps in position sizing and using pending orders such as buy or sell limits and stop loss and take profit orders.
Disadvantages: High volatility or low liquidity can lead to requotes of the initial spread to a wider one. Requotes are sent through trading platforms from the broker when a trader wants to trade at a specific price.
Floating Spread: A floating spread is also known as a variable spread; it means that the spreads between currency pairs are constantly changing based on the market conditions. Non-dealing desk brokers offer variable spreads because they get their pricing of forex pairs from several liquidity providers. This means that brokers don't play a role in specifying the spreads. The spreads can only be affected by market volatility, liquidity, and conditions.
Advantages: In stable market conditions spreads would be narrow and usually cheaper than a fixed spread. Depending on the instrument and broker a trader is dealing with, the best bid is offered at a certain time. This method allows traders to be able to perform trades without getting a requote or slippage with potentially tighter spreads during high liquidity hours.
Disadvantages: When market fluctuations are minimal, spreads widen substantially, resulting in higher costs between trades. Traders might find the unpredictability quite a challenge and it may be difficult for them to calculate their trading costs at times. Sometimes wide spreads can even result in slippage, and trading costs may be less favorable than expected.
Zero Spread: A zero-spread account is an account with no difference between currency pairs, meaning that the bid and ask prices for a currency pair are identical. With spreads being zer,o traders can execute trades closer to the market price, and it allows them to have better control over entry and exit points.
Advantages: Traders can easily calculate their losses and benefits because a zero-spread account simplifies that. Traders with a zero-spread account often enter and exit a position quickly and at their desired price. It also helps account for reducing trading costs in the forex market during extremely volatile hours.
Disadvantages: Zero spread accounts may not be available for all currency pairs, and they may not be suitable for various strategies. Read more about what a zero-spread account is.
How is the Spread Quoted?
The smallest movement between currency pairs in the forex market is called a pipet (point), and the spread is usually quoted in points. It is essential for traders to understand how pips and points work and how they are valued in order for them to make more informed trading decisions and better management of forex trades. A spread’s pip value can vary depending on the forex currency pair and the size of the trade.
Spread is often calculated in points, which is a fundamental aspect of forex trading, guiding traders to quantify price movements, manage risks, and calculate trading costs. Point refers to the smallest price change that can possibly happen on the left side of the decimal. A pip is equivalent to ten points, so any movement as small as that can be calculated in points.
How is Spread Calculated in the Forex Market?
Calculating spreads may be confusing for some traders, especially if they are frequent traders. However, calculating pip values depend on the currency pairs, trade volume, and exchange rate of the pair. To calculate the dollar amount of the spread, simply multiply the spread in points (depending on the asset) by the contract size. For example, if the spread between a currency pair is 2 pips and each pip is worth $10, then the spread in dollars is $20.
Mishov Markets provides different calculators with accuracy, and one of them, the Spread To USD calculator, helps traders calculate spread in dollars quickly and precisely, which is quite beneficial when it comes to trades in larger volumes.
What is Spread Cost in Forex?
Spread refers to the difference between the bid and ask price of a currency pair in forex trading. For example, if the bid price for EUR/USD is 1.12050 and the ask price is 1.12053, the spread between this pair is 0.3 pips (3 points), which is a small cost built into every trade of this currency pair.
Spread can change based on different factors, including:
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Currency Pairs: Different pairs have different spreads. Generally, major currency pairs tend to have tighter spreads than pairs with low liquidity.
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Market Conditions: Different times and conditions can cause spreads to widen or tighten during times, traders should carefully manage risk amidst high volatility to avoid loss.
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Brokers: Different brokers may offer different spreads, some may even offer fixed or zero spreads.
Tighter spreads generally mean lower trading costs, which are often favored by most traders.
What is a High Spread?
Spread represents the gap between the bid and ask price of currency pairs. Similarly, a high spread means a larger gap between these currency pairs. A higher spread also signifies lower liquidity or higher volatility in the current equity market. For example, currency pairs that are not traded as much as major currency pairs tend to have high spreads.
This also increases the transaction cost, which can be a disadvantage for the traders. Traders usually require tight spreads to maintain profitability. Mishov Markets offers narrow spreads in several currency pairs to keep trading favorable for traders.
What is a Low Spread?
A low spread also known as a tight spread, is generally preferred by most traders. A lower spread represents a smaller difference between the bid and ask price of a currency pair. A tight spread is typically found in markets with high liquidity and significant trading volume.
Major currency pairs like GBP/USD or EUR/USD often have lower spreads because of their high liquidity.
Low spreads bring down the transaction cost and allow traders to enter and exit a trading position with minimal cost. Low spreads can significantly enhance profitability by reducing overall trading expenses.
What is a Good Spread in Forex?
A good spread in forex can’t be simplified to one exact answer, but usually, a lower spread is considered better for traders, as it reduces the cost of entering and exiting trades. For major currency pairs like EUR/USD, a spread of 1 to 2 is typical, while for less liquid or exotic pairs, the spreads may be wider. For brokers, offering a competitive spread can attract more clients, while still allowing them to make a profit from the trades. From a trader’s perspective, a narrow spread is the best for faster execution, especially for short-term strategies like scalping. However, traders who are dealing with wider spreads expect larger price movements to cover their trading costs. When evaluating a broker, it’s important to consider the spreads according to your strategy, but it’s also essential to look for other factors such as execution speed, liquidity, and customer services to ensure overall value.
