If you’re new to the world of forex trading, you may have come across the term “spread” and wondered, “What is spread in forex?”
Understanding spreads is crucial for every forex trader, as it affects your trades and profits.
In this beginner’s guide, we’ll delve into the concept of spread, explain how to calculate it, discuss different types of forex spreads, and explore various forex spread trading strategies.
By the end of this article, you’ll have a solid understanding of forex spreads, empowering you to make more informed trading decisions.
So, let’s get started!
- What is Spread in Forex Trading?
- Types of Forex Spreads
- Forex Broker Spreads:
- How to Calculate Spread in Forex
- Understanding the spread in Trading
- How The Market Spread Affects Trade Entry and Exits
- What is Forex Spread? – Graphical Explanation
- What is Spread in Forex? FAQ
What is Spread in Forex Trading?
In forex trading, the spread refers to the difference between the bid price (the highest price a buyer is willing to pay) and the ask price (the lowest price a seller is willing to accept) of a currency pair.
The spread is usually expressed in pips, the smallest unit of price movement in forex.
For instance, if the bid price for the EUR/USD currency pair is 1.2000 and the ask price is 1.2005, the spread is five pips.
Types of Forex Spreads
There are two main types of forex spreads: fixed and variable.
Fixed spreads remain constant regardless of market conditions, while variable spreads can widen or narrow depending on market volatility.
Some brokers also offer floating spreads, which are variable spreads that are often lower than fixed spreads.
Therefore, based on the type of spread offered, some brokers are called fixed-spread brokers, and others are called variable-spread brokers.
Forex Broker Spreads:
Choosing the Right Broker Choosing the right forex broker is crucial, as it determines the spreads you’ll be trading with.
Some brokers offer tight spreads, which can benefit scalping or day trading strategies.
In contrast, others may have wider spreads but provide additional services such as educational resources, research tools, or access to various markets.
Researching different brokers and comparing their spreads, fees, and other features is essential before opening an account.
How to Calculate Spread in Forex
To calculate the spread in forex, subtract the bid price from the ask price and multiply the difference by the lot size (the number of currency units traded).
For instance, if the bid price for the EUR/USD currency pair is 1.2000, and the asking price is 1.2005, the spread is five pips.
If you’re trading 1 standard lot (equivalent to 100,000 units), the spread cost would be $5 (0.0005 x 100,000).
As promised, I would like to explain this to you like a five-year-old; check this out;
If you want to buy a certain type of money (called a currency), you have to pay a little more than others are willing to sell it.
And if you want to sell that type of money, you have to sell it for a little bit less than what other people are willing to buy it for.
The difference between what you must pay to buy and what you get when you sell is called the “spread.”
To calculate the spread, you need to subtract the price you would get if you sold the currency (called the bid price) from the price you would have to pay if you bought the currency (called the ask price). The result is how much money you would lose just to make the trade.
For example, if you wanted to buy some euros and the bank’s asking price was 1.20 dollars for one euro, but the bank’s bid price was only 1.1995 dollars for one euro, the spread would be 0.0005 dollars.
If you wanted to buy 100 euros, you would have to pay 120 dollars (100 euros x 1.20 dollars/euro), but you would only be able to sell them back for 119.95 dollars (100 euros x 1.1995 dollars/euro). So the total cost of the spread for this trade would be 0.05 dollars (0.0005 dollars x 100 euros).
Understanding the spread in Trading
The spread is an inevitable part of trading. The spread simply is the profit that the brokers take.
While trading forex through a trading account, it is important to notice that the broker does not charge a fixed monthly fee for operating the account.
The broker does not take any direct transaction charges for entering a trade either.
Instead, the broker offers two different currency trade prices, often called ask and bid prices.
These pieces describe the intentions of the broker.
The broker is bidding and offering. You buy at the bid price and sell at the asking price.
The difference is called the spread and is the broker’s profit margin.
How The Market Spread Affects Trade Entry and Exits
A scenario that many beginner traders find complicated is understanding the spread in a stop loss and take profit.
Beginner traders often complain that the broker didn’t allow them into a trade immediately after placing an order.
Others say the broker quite practically didn’t honor their stop loss and exceeded it. It’s all got to do with the spread.
Many traders don’t know how to factor the spread into orders, and this is what I am about to explain to you.
You might think your orders are delayed due to app bugs or internet service provider delays.
Both assumptions are wrong.
Fundamentally, there are two prices on your chart. There’s the bid price, mostly what you see on your candlestick and the asking price.
Generally, most charting software would generate the market data/price off the bid price.
A good example of a trading platform that does this is the Metatrader4 broker software (MT4).
The two prices (ask and bid) work hand In hand, no matter the position or order you take on the exchange platform.
Simply put, the broker takes you out or inserts you into a trade when the price level gets to the asking price.
Underlisted below are the key takeaways.
- The broker puts you into and takes you out of a trade based on the ask/offer price
- Most Forex charting software display market data based on the bid price
- it is essential to be aware of the spread when setting takes profits and stops loss.
- Delays in trade entry and exits aren’t because of bugs or ISPs
What is Forex Spread? – Graphical Explanation
The pink line represents my take profit, while the dotted green line represents my trade entry position.
The red dotted line above represents my stop loss which is visible right above the high of the third reversal candlestick.
My current position is a sell order, as I predict the market will fall.
The most important thing to notice is that the broker wouldn’t place me into the trade until the bid price (my entry point) crosses the asking price (the red dotted line above the green line). This is because of the presence of the spread.
The same thing applies to where I put stop-loss. I initially wanted to place my stop loss right below the high of the third reversal candle.
But because of the awareness of the spread, I placed it a few pips after the high.
NB; For a charting platform that uses the bid price as its market data, you can make the asking price visible in the settings.
The Broker typically earns his gain from the spread.
Therefore, knowing how to manipulate and work around the spread is one of the fundamentals of trading.
Knowing how to work with the spread allows you to make more informed trade decisions in any timeframe.
What is Spread in Forex? FAQ
Conclusion – What is Forex Spread?
In conclusion, trading on the forex market requires constant learning.
Understanding how the forex spread work is one of the benchmarks for trading success.