WHAT IS A FOREX SPREAD?
As a Forex trader, it is essential to have an in-depth knowledge of how Forex spreads work - they are the major rate of trading currency pairs.
Price disparity in Forex
The Forex market, like any other trade market, has a spread. Simply defined, a Forex spread is the disparity in price between the cost and selling price of a currency pair. It is commonly referred to as the “Ask price” and the “Bid price” in the Forex market.
If a trader is working with a Forex broker, the broker provides two different prices of a currency pair, the buy/ask price and the sell/bid price.
- The “ask” price is the price at which the base of a currency can be bought.
- The “bid” price is the amount at which the base currency can be sold.
The spread is the difference between the two prices listed by the Forex broker.
Some Forex brokers who do not charge commissions on trades profit from spreads.
Rather than charging a commission, they include the fee in the Ask and Bid price of the currency pair being exchanged.
Most Forex brokers that claim to offer zero or no commissions are not fully honest. Despite the fact that there is no separate charged commission, they nonetheless make their traders pay a commission through the spreads.
It is understandable from a business perspective. The broker provides a service and must make money regardless of trader performance.
Types of Forex spreads
There are two main types of spreads in Forex trading, although they can vary depending on the Forex broker.
The two main types are:
- Fixed Spreads
- Variable Spreads, also referred to as “floating”
Fixed Forex spreads
These types of Forex spreads remain the same regardless of the outcome of the Forex market. The spread remains constant regardless of whether the Forex market is volatile or stable.
This type of spread is more common among Forex brokers who operate as market makers or dealing desk types.
A dealing desk broker is one that purchases large lots or positions from liquidity providers and then sells them to traders in lesser quantities.
Advantages of Trading Fixed Spreads
Fixed spreads require less capital, making it a more reasonable choice for traders with limited capital. Furthermore, fixed Forex spreads make calculating transaction costs more stable.
Disadvantages of Trading With Fixed Spreads
Continuous Forex trading with a fixed Forex spread may result in requotes since the price is only coming from one source, which is your broker.
A requote is a notification that appears on your trading platform when a broker blocks you from executing a trade due to a price change. In most situations, the required price is always greater than the prior price at which the trade was purchased.
Slippage is common with fixed Forex spreads. When prices are volatile, the Forex broker will almost always be unable to maintain a fixed spread, which may result in a trade with a completely different entry price than you intended.
The importance of Pips in Forex Trading
Variable spreads are the opposite of fixed spreads. These are continuously changing spreads, as the name indicates. In this situation, the disparity between the purchase and sell prices of currency pairs is constantly shifting.
Variable Forex spreads, as opposed to fixed spreads, are primarily utilized by non-dealing desk brokers. This simply implies that these Forex brokers have no control over the spreads because they obtain their prices from various liquidity sources and provide the same rates to traders.
This means that Forex spreads can either increase or decrease, depending on the volatility of the Forex market and the supply and demand for currencies.
Wide Forex Broker Spread
For example, let’s say you wish to buy EUR/USD with a spread of 2 pips. Just before you are ready to buy this currency pair, a report detailing US unemployment statistics is released, causing the spread to widen to roughly 20 pips.
The Advantages of Variable Spreads
Requotes are never possible with variable spreads. This is due to the variation in spread conditions, which fluctuate in price in response to market conditions.
Variable spreads in Forex trading provide for greater transparency in pricing, particularly by providing access to the varied prices of many liquidity providers; it also allows for competition, which leads to fair and better pricing.
Disadvantages of Variable spreads
Variable spreads are not advantageous to scalpers. This is due to the fact that if the spread widens, the scalper’s profits might simply be wiped away.
High spread and low spread
Spreads in Forex trading can change at any time, ranging from a small spread to a large spread.
The fluctuation is owing to the various factors influencing the spread, such as market liquidity and volatility. Major currencies often have a lesser spread, whereas minor currencies have a greater spread. This feature is due to the fact that large currency pairs are traded in higher volumes than smaller currency pairs, and a high volume of trade results in a low spread under normal market conditions.
High Forex Spread
A wide Forex spread is a significant difference between the purchase and sell prices of a currency pair. This is more applicable to minor currency pairs than major currency pairs.
When a spread is wider than usual, it might be due to increased market volatility or a lack of liquidity. Furthermore, spreads may increase significantly before major news events or announcements, such as elections.
Low Forex Spread
In Forex trading, a low Forex spread indicates that there is minimal difference between the buy and sell prices of a currency pair. When spreads are low, it is convenient to make a trade; a low spread typically implies that liquidity is high and volatility is low.
Learning to Calculate Forex Spreads and Costs
In Forex trading, the spread is often measured in pips. The smallest unit of a currency pair’s price movement is referred to as a pip.
To simplify things, the spread of a currency is just the difference between the ask and bid prices of a currency pair; the bid price of a currency pair subtracted from the ask price of the same currency pair.
For example, suppose you purchased EUR/USD at 1.1722 and then sold it at 1.1726. The quote indicates a 4-pip spread. To determine the overall spread cost, multiply the pip cost by the total amount traded.
For example, if the total amount of EUR/USD lot traded is 10,000, the total amount of spread cost will be 10,000 X 0.0004 = $4. In a case where you’re trading a standard lot of 100,000, your spread cost will be 100,000 x 0.0004 = $40.
An illustration of a EUR/USD with a 2-pip spread would be 1.1071/1.1073.
Please keep in mind that one pip of most currency pairs is equivalent to 0.0001. Always remember that the fourth digit following the decimal denotes the currency pair’s pip value. When trading currencies like GBP, you must first convert them to US dollars.
Factors that affect changes in the Forex spread
One of the primary factors influencing the change in the Forex spread cost of a currency pair is market volatility. Key economic indicators can prompt a currency pair to weaken or strengthen, influencing the Forex spread. When the Forex market is turbulent, the currency pair loses liquidity, driving the spread to widen.
Keep an eye out for the economic calendar. When you are fully informed about upcoming events that may have a negative impact on your trade and its liquidity, you are better able to forecast the right movement of the Forex market. It also assists you in determining whether there will be an increase in volatility. However, when unexpected economic data is released, it might be difficult to manage.
Forex market sessions
Forex spreads are expected to be narrower during major Forex market sessions, such as those in London, Sydney, and New York.
The Forex spread is also heavily influenced by overall currency demand and supply. If there is a high demand for particular currency, the value will increase.
Variable Forex spreads
In brief, Forex traders buy or sell a currency pair, and the value of the pair is represented in respect to another currency. Forex currency pairs are expressed in pips, which represent the fourth decimal place of the value. A pip is also defined as one-hundredth of one percent.
Even though a pip may appear insignificant, as a Forex trader, a one pip difference may mean major profits or losses, depending on the capital invested.