Forex Trading Spread Explain, By Forex Forum.
Spreads are an essential part of forex trading—and at first glance, they might seem a bit daunting. They change rapidly, involve math, and worst of all, multiple decimal places. They look indecipherable—but if you put in a little effort, they're actually quite easy to understand.
Forex trading isn't simple. Although we're witnessing an explosive rise in the number of new traders, the fact remains that over 70% of retail traders, meaning individuals, end up losing money in the foreign exchange market.
What are forex spreads?
FOREX Spread is is the difference between the Buy and the Sell price of any given asset (varies with every broker).
In one of the most common definitions, the spread is the gap between the bid (sell price) and the ask (buy price) of a security or asset, like a stock, bond or commodity. This is known as a bid-ask spread.
Brokers will tell you that most forex currency pairs are traded without commission, but the spread is one cost that applies to any trade that you place. However, rather than charging a commission, all leveraged trading providers will incorporate a spread into the cost of placing a trade.
Why is a spread taken?
A spread is taken to cover the broker's cost for executing orders. It costs all brokers to place the trades on your behalf, not to mention the cost of developing the platforms, paying employees, marketing etc. It takes a large amount of money for a broker to operate, and this is partially financed by the spread taken from clients - a primary source of funding. Without it, brokers would risk not being able to be financially sustainable as they'd rely solely on traders losing money to earn profits.
How to calculate spreads in forex?
The impact of spread on trade profitability is often overlooked. Going from a 3-pip spread to a 2-pip spread may not sound like much, and going from a 2-pip spread to a 1.8-pip spread may seem even less significant. But in both cases, depending on your trading style, the impact on profitability can be huge.
When calculating the spread in forex, the most important thing you need to remember is that 1 pip will be equal to the 4th digit after the comma, or the 4th decimal place. For the following example, we will take a look at the most commonly traded pair on the forex market, the USD/EUR.
If you have a sell price of 1.12496, and a buy price of 1.12500, we can see that the difference is 0.00004. Taking our method above with the fourth number after the comma, this means the spread is equal to 0.4pips.
Every trade that occurs on a Forex trading platform will always include two traded currencies also known as a pair. Let's take the British Pound (GBP) and the Japanese Yen (JPY) as a prime calculation example to calculate a sample spread cost that a potential day-trader might inherit for executing one trade. Let's say the GBP is worth 140 Japanese Yen. You believe that the JPY will appreciate by 5 to 145 against the dollar so you place a buy order for 10 units of JPY.
The closest ask-price for 1 GBP is 142 JPY, so you then proceed to place your order. Meanwhile the JPY seller on the other side of the table may have a bid priced at 143. In this case the spread will be calculated as (143-142 YEN) x 10, or 1 Yen for 10 units.
You can also search the internet for various Forex spread calculators that will further assist you in performing simple calculations that will go a long way in putting you in the best possible position to minimize trading costs and maximize profits. You can join a forex forum to learn more about forex trading spread.
Forex spread calculator works this way:
Spread % = (ask price - Bid price) / ask price x 100
Input the Ask price
Input the Bid price
Forex spread types - How many are there?
Although every spread type has one purpose of earning the broker some income they still come in different shapes and sizes. There are way too many to mention here, but the ones that are most important to know about are the following:
- Bid/ask spread
- Yield spread
- Option adjusted spread
- Negative spread
- Z spread
However, we will still only talk about Bid/ask spreads, Yield spreads and negative spreads as the others are a bit more advanced.
1. What is bid/ask spread
When asking for what is the spread in Forex, people usually mean bid ask spreads, as they are the most common ones to find with Forex brokers because they are such an easy way to get payouts for them. The difference between the bid and the ask price is pretty much what you are paying the broker to receive their service. Although 1 pip may sound really small for making a good income for a company, remember that spreads are calculated according to the size of the lot you are trading.
The BID Price
The BID price is something that you will be very familiar with. The BID price is the price you see on the charts so if EURUSD was printing 1.3000 on your chart then the BID price is 1.3000.
The ASK Price
The ASK price is where things get a little more complicated, the ASK price is responsible for causing those unexpected 'glitches' in your trade orders.
2. Yield spread
Yield spreads are also pretty much the same as bid and ask spreads, but they are usually calculated for different assets. For example, the most popular asset that yield spreads are associated with bonds and here's how they calculate them.
If there are two bonds of equal size and value, the difference between their yields will result in a yield spread.
So, if one bond has a yield of 10% and another has a yield of 5%, this would mean that the yield spread is only 5%.
3. Negative spreads
Negative spreads are only negative for the brokers themselves. Basically what a negative spread means is that you can trade without having to "pay" the broker anything from your trade orders.
4. Fixed and floating spreads
This is not necessarily a "type" of spread for Forex trading simply because every single spread can be either fixed or floating. They're like the types of the types of Forex spreads. A fixed spread is when the broker guarantees that no matter what happens in the market, the spread will remain the same. So, if the spread on EUR/USD was 1 pip, it will stay that way no matter what.
UNDERSTANDING A HIGH SPREAD AND A LOW SPREAD
It's important to note that the FX spread can vary over the course of the day, ranging between a 'high spread' and a 'low spread'.
This is because the spread can be influenced by multiple factors like volatility or liquidity. You will notice that some currency pairs, like emerging market currency pairs, have a greater spread than major currency pairs. Your major currency pairs trade in higher volumes compared to emerging market currencies, and higher trade volumes tend to lead to lower spreads under normal conditions.
Additionally, it's well known that liquidity can dry up and spreads can widen in the lead up to major news events and in between trading sessions.
The Lowest Spread Forex Brokers:
- FOREX.com
- Pepperstone
- IG Markets
- FXTM
For learn more about forex brokers click here...
Why do spreads widen?
When you place a trade, you are effectively taking on the broker as they assume the risk and are the ones who will pay you out if your trade is profitable. When markets are specifically volatile and it's completely unclear as to which way the market will go and by how much, brokers are obtaining more risk by accepting trades. This is because a market is more likely to make a greater move, which could lose the broker a lot of money. So, to counter this risk, a broker might widen the spread.
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