Forex trading is known as the largest financial market in the entire world and it is a marketplace for everyone who wants to make a potential profit from the fluctuations of currencies. But one of the most essential things any trader should master is the spread.
It is one of the determinants of trading costs and, therefore, profitability. If you’ve been asking yourself questions like “What is spread in forex?” In this blog, we are going to explain to you what these spreads are, how they are computed, and what affects them.
You will also find out how spreads contribute to the trading strategies and you will master ways to cut costs and gain more profit in the forex market. At the end of the article, you will be equipped with comprehensive knowledge of spreads and their role in trading in the forex market.
In forex, the term spread relates to the price difference between the bid (price at which one can sell a given pair of currencies) and the asking (price at which one is capable of buying the same pair of currencies). In reality, it means the cost of trading more specifically. Brokers make their profit through the spreads and this is one aspect that can inform a trader when choosing a broker to undertake online forex trading.
For example:
It’s an essential factor when participating in online forex trading since the spread is the fee that the broker requires for making the trade.
This spread determines the extent of profitability for a trader in a particular trade. When one gets into any trade, he starts with a small loss equal to the spread amounts. For example, if it is 3 pips, a market must reverse 3 pips in your favor before you begin to turn a profit.
Scalpers pay the spread as it is the most significant cost associated with trading for the traders involved in a great number of trades in a short time.
If the spread is drawn out then fewer profits are earned by traders, if the spread is tight then more profits are retained by traders.
This kind of trading calls for improved trading methods that ensure that the spread the trader is willing to venture in is very small while a certain kind of trading may allow one to enjoy a wider spread.
They claimed that spreads can change according to the used broker and present market parameters. Let’s look at the two main types of forex spreads:
Calculating the spread is straightforward:
Lot Size = Ask Price – Bid Price
Example:
Spreads are measured in pips which is an acronym for Percentage in Points, the smallest price movement in forex. A pip is usually equivalent to 0.0001 for all major pairs and 0.01 for the yen pairs.
If you trade 1 lot (100,000 units) of EUR/USD with a 2-pip spread:
This $20 is what you would require to incur in the trading process before you can incur a profit.
Contrary to what we may think, spreads aren’t fixed in any given amount, they are dynamic.
High Liquidity: For instance, EUR/USD being among the most traded currency pairs, we observe that the spread is relatively smaller.
Low Liquidity: The exotic pairs have a wider spread since fewer numbers of traders are involved in trading the exotic pairs.
Spreads also fluctuate depending on levels of volatility, in the case of either an announcement about the economy or tension between countries for instance.
Tighter Spreads: Especially, during the forex trading weekdays such as London or New York sessions.
Wider Spreads: During off-peak hours.
While market makers fixed spread, the ECN (Electronic Communication Network) brokers offer the variable spread.
Depending on the trading technique it is virtually imperative to assume diversity on spreads. Let’s explore how spreads impact popular strategies:
Also, cutting the spread costs may have a very positive impact on your business’s gross profit. Here are some practical tips:
Some brokers base their form of charging on spread whereas others charge fees based on commission.
The choice depends on your trading style:
Leveraging the right tools can help you monitor spreads effectively:
Consider a trader opening a position on GBP/USD:
For a trade size of 1 lot (100,000 units):
This $30 is deducted as the trading cost when the position is opened.
Indeed, it is crucial for any trader who intends to operate in the forex market to have some idea of what spreads are and how they operate. Spreads are the price you pay for the trading and are always a vital factor when it comes to evaluating your profitability. Due to this traders ought to choose the right broker, trade during high volume periods, and use strategies that correspond to the spread to minimize costs and improve performances.
Forex trading using the internet will help you understand that brokers and their Forex trading spreads differ. Applying those tips and strategies mentioned above in your trading procedures can help you to make the right decisions.
Q1: What is meant by spreads in forex and why they are considered?
A: Spreads are also the gaps between bid and ask prices. They act with trading costs and affect the overall profitability.
Q2: Are the spreads flexible during a trade?
A: Of course, it can happen that spreads expand or contract depending on some pre-determined factors, like volatility or liquidity.
Q3: Is a tighter spread necessarily beneficial?
A: Tighter spreads are effective at reducing costs yet the cost might be pegged on commission fees. The appropriateness of the chosen broker largely depends on how you trade before you arrive at your decision thus, they are.