"What is spread?" is one of the questions that beginners of the Forex market often wonder about. Spread is an essential factor in Forex trading as it directly affects the profit and the amount you pay when opening and closing a position. So, what is spread exactly? What should traders pay attention to in order to trade successfully? Find out in this article.
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What is Spread?
Spread is the difference between the buying and selling price of a currency pair. It represents the gap between the price that buyers are willing to pay and the price that sellers are willing to accept. The spread is calculated by currency units and represents the trading fee charged by the broker for executing a trade. When you open a trading position in Forex, you have to pay the spread to your broker.
Spread is also referred to in two terms: Bid and Ask.
Bid: The price at which the trader is willing to buy a currency pair. It is usually lower than the ask price. When you want to sell a currency pair, you will receive the bid price if the trade is successful.
Ask: The ask price is the price at which a trader is willing to sell a currency pair. It is usually higher than the bid price. When you want to buy a currency pair, you have to pay the ask price to execute the trade.
The importance of spreads in Forex
When learning about “what is spread”, we can understand its significance in Forex trading and its direct impact on trading fees, profits, and other important factors.
Trading fee: Spread is a fee that traders have to pay to brokers when opening a position. When you buy and sell currency pairs, you have to pay the corresponding spread, which is the difference between the bid price and the ask price. A higher spread means higher trading fees, reducing profitability.
Profit and R:R Ratio (Risk/Reward): Spread directly affects profits and the risk-to-reward ratio in trading. To earn profits, prices need to surpass the spread to generate income.
Broker Selection: Understanding “what is spread” helps in choosing a suitable broker. Each broker has its own spread policy, and there can be significant differences between brokers. Traders need to consider the level of spread offered by a broker and decide between fixed or variable spreads.
Trading Strategy: Spread can also impact your trading strategy. With higher spreads, you may need to set larger profit targets to compensate for trading fees. If you prefer short-term trading or require high accuracy in entry and exit orders, smaller spreads are more advantageous.
Types of spread in Forex
To further understand what is spread, let's explore the different types of spreads available in the market. There are three main types of spreads that brokers commonly offer:
Fixed Spread: This is a type of spread where the broker determines a fixed value for the difference between the bid and ask prices. Regardless of market volatility, the spread remains constant and does not change. This helps traders easily calculate fees and profits in their trades.
Floating Spread: This is a type of spread that varies based on market conditions. The spread can expand or narrow depending on fluctuations and liquidity. When the market experiences high volatility, the spread may increase, while during quiet market conditions, the spread may narrow.
Variable Spread: This is another form of a floating spread. The broker provides a range for the spread and allows it to change within that range. For example, the broker may specify a spread range of 1-3 pips for a specific currency pair. The spread will fluctuate within this range depending on market conditions.
Both Fixed spread and Floating spread have their own advantages and disadvantages. Fixed spreads make it easy for traders to calculate profits while floating spreads offer flexibility depending on market conditions. Traders should consider these factors when choosing a broker and the type of spread that aligns with their trading strategy.
How is spread calculated in Forex?
Many people when learning about “what is spread”, are also curious about how spread is calculated. In addition to understanding “what is spread”, it's important to know how to calculate it to ensure profitable trades.
Spread is typically displayed in the form of pips (points) or as a percentage. A pip is the smallest measurement unit in the value of a currency pair. For example, if the spread for the EUR/USD currency pair is 2 pips, it means the spread between the buying and selling price is 0.0002 USD.
For example, if the bid and ask price of a currency pair are 1.2000 and 1.2005 respectively, the difference between these two prices is 0.0005. This is equivalent to 5 pips.
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In some cases, pips can be displayed with 5 composite numbers to represent a higher level of accuracy. For example, a spread may be shown as 0.00005, which is equivalent to 0.5 pips.
Measuring spread in pips gives traders a clear view of the trading fees and calculates profits in buying and selling positions in the Forex market.
Factors affecting spread
When learning about “what is spread”, it's important to understand the factors that can influence it. Here are some key factors:
Liquidity: Market liquidity plays a significant role in determining the spread. When a currency pair has high liquidity, meaning there is strong buying and selling activity with sufficient traders, the spread tends to be lower. Conversely, when liquidity is low, the spread can widen.
Market volatility: If you know “what is spread”, you'll understand that market volatility also affects it. When the Forex market experiences high volatility, the spread can expand to reflect the uncertainty and risk involved in executing trades. Market conditions, including the impact of news, economic events, or even different trading sessions within a day, can create price fluctuations and impact the spread.
Broker's policy: Each broker may have its own spread policy. Brokers can adjust the spread based on market conditions, trade size, and account type. The broker's policy directly affects the level of spread you have to pay when trading. Therefore, once you understand “what is spread”, you can find a broker that is suitable to your trading strategy.
Account type: This is also an important factor when learning about the spread. Some brokers offer different types of accounts, ranging from basic to ECN (Electronic Communication Network) accounts. Different account types may have varying spreads and trading conditions. ECN accounts typically have lower spreads due to the direct trading conditions with liquidity providers.
By understanding "what is spread", you'll be aware of the factors that can cause spread fluctuations. From there, you can adjust your trading plan accordingly to best suit your needs.
After reading this article, you surely know “what is spread”. Traders also need to pay attention to the spread fee in order to choose the most suitable trading strategy. This is especially important for traders who engage in short-term trading and generate multiple orders, as they need to be mindful of the spread fees. It significantly affects both losses and profits.
Hopefully, you understand “what is spread” and you will be able to select a broker that aligns with your strategy the best. May we all have a successful and remarkable trading journeyFollow the latest news from FXCE: