Forex spread is one of the basic things to understand for beginner traders.
One of the most frequent questions on the lips of budding traders usually is ‘’what is a forex spread?’’.
Simply put, the spread is the difference between the ask and the bid price on a currency pair.
The spread is measured by the movement of pips on the forex market.
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 prices for currency trade, often referred to as 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.
Consider this example – What is forex spread?
These are the prices at which you can buy and sell Eurodollar. The price you can sell them to the broker is 1.2612.
This is the bid price or what the broker is bidding to buy your currency at.
Inversely, when buying the currency pair from the broker, you would have to pay 1.2614 nonetheless.
This is called ask/offer or what the broker is willing to sell you the currency.
In this scenario, the difference between 1.2612 and 1.2614 is 2pips. This is your spread.
How The market spread affects trade entry and exits – Understand the Dynamics
A particular scenario that many beginners’ traders battle with is understanding the spread in a stop loss and take profit.
Several times, traders make complaints saying that the broker didn’t insert them into a trade as at when they placed the 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.
A lot of traders don’t know how to factor the spread into orders.
You might think your orders are being delayed due to bugs on the app or delays from the internet service provider.
Both assumptions are wrong.
Fundamentally, there are two prices on your chart.
There’s the bid price which is 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.
What is Forex Spread – Picture 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 am predicting the market will fall.
The most important thing to notice is, that the broker wouldn’t place me into the market 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.
Knowing how to manipulate and workaround 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
Key takeaways?
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 important 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
Conclusion – What is Forex Spread
Trading on the forex market requires constant learning.
Understanding how the forex spread work is one of the benchmarks for trading success.
Terminologies like spread, fundamental analysis, Technical analysis all require you to constantly put yourself in a position where you have to learn and evolve your trading technique
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