Spread in Forex Explained - Definition/Meaning & Examples

A spread in forex is the difference between the bid (sell) price and the ask (buy) price of a currency pair and essentially represents a broker's way of making money without charging a commission on a transaction.

It is important for new traders to understand how forex spreads work, how they are calculated and why they exist in the first place. 

• Here are some important questions to ask yourself before choosing a broker:
• How does one broker's forex spread compare to another?
• Does the spread seem reasonable or is it excessive?
• If the forex spread is too high, what does that say about the broker and the investment?
• Does the spread indicate high or low risk?

But don't worry, determining a spread is a lot easier than it seems.  

How to Calculate a Forex Spread

Here are a few examples of popular currency pairs:

If you trade the EUR/USD at 1.1339/1.1340, the spread is 1.1340 - 1.1338 = 0.0002, or 2 pips.
If you are trading the EUR/GBP or the bid 1.1036/1.1039 ask, the spread is 1.1039 - 1.1036 = 0.0003 or 3 pips.

This calculation applies to all currency pairs, regardless of whether they are major currencies (major), minor currencies (majors) or exotic currencies (exotics).

Remember that in forex trading you are charged the entire spread when you open a trade. This is exactly why a trade is always opened in the red, because the spread is calculated right at the opening.

Beware of spreads

As already mentioned, trading beginners must carefully examine the spreads offered by the brokers.  

Why? This is ultimately decisive for the costs that you pay for foreign exchange trading or forex trading.  

Brokers often offer commission-free deals as an incentive to attract clients to their online trading platforms, which is generally not a bad thing. But then they will often factor the cost of the transactions they make into the spreads.

So don't be tempted too quickly by the offer of commission-free trading - not that you then have to find out that a broker's spreads are particularly high and you would have been better off with a commission.

Broker's motives

Brokers have two main drivers for higher spreads:

This is how they make money
In this way, they protect themselves from the risk of constantly executing incoming buy and sell orders at market prices
It is important to find a broker that offers the cheapest spreads in comparison. If the spreads offered are unreasonable or abnormally high, you should choose a broker who will give you a better deal.

Of course, there is a good range of brokers that have reasonable spreads:

Featured forex brokers with low spreads

If spread is higher, The cost will be higher

While it's a smart way for brokers to make money on each trade, a higher spread can also show how risky your investment is.  

A spread is often determined by the currency being traded, its volatility, liquidity and market factors.

The larger the spread (spread) between the bid and ask prices, the greater the risk involved in trading. Conversely, the narrower the spread, the lower the risk.

To balance risk and unexpected costs, you can choose the type of spread that works best for you. There are two types:

• fixer
• Variable

What is a fixed spread?

Fixed spreads usually remain the same and are offered by brokers who act as market makers or dealing desks.

Advantages:

• They have lower capital requirements
• They suggestion a cheaper substitute for traders with less money
• They make it easier to evaluate business prices
• You have some certainty about the cost of your trade

Disadvantages:

• Frequent subsequent listings (requotes), which are usually worse than the original listing (quote)
• Brokers block trades based on new prices
• The broker is unable to meet the specified spread (deviations)

What is a floating spread?

The spread is constantly changing depending on market conditions and is offered by brokers who are non-dealing-desk brokers and source their quotes for currency pairs from multiple liquidity providers.

Advantages:

• No requoting
• more transparency
• Better course design

Disadvantages:

• May reduce profit margin
• Influenced by news
• Profit can erode quickly

What affects spreads?

As before declared, exterior market aspects can have a important impact on forex spreads any way.

Here are certain to keep an judgment on:

• market volatility
• political uncertainty
• Breaking News
• Important economic indicators
• lack of liquidity

Suggestion for traders:

• Follow the news closely
• Follow a current Forex economic calendar
• Monitor current economic data
• Be informed

Spreads on exotics (Exotics) versus major currency pairs (Majors)

Emerging market currency pairs tend to have wider spreads than major currency pairs because they are less liquid and vulnerable to greater political and economic uncertainty.

Conversely, better known currency pairs - like EUR/USD or EUR/GBP - have cheaper spreads than exotic currency pairs as they are seen as more predictable investments in stable economies.

How to determine the spread and cost?

Just when you thought you figured out how to determine a spread, there's one more calculation you need -- the total cost of a spread.

Don't be intimidated, it's only slightly more complicated than determining the spread itself.

Here's how it works: Spread in pips x lot size = spread cost

For example, if you trade a mini lot of USD/EUR (10,000 units) and the cost is 0.0001 (1 pip per unit), the resulting amount is €1.

Conclusion

If you want to start your Forex trading journey, all you have to do is answer the questions mentioned in the introduction.

This will save you from being overcharged by a broker – even if they offer commission-free trades. This will protect you from risky investment decisions!

Also remember that the higher the spread, the lower the profit margin for each unit purchased. Conversely, the narrower the spread, the more money you can make from your investment.

And always keep in mind: Forex spreads are influenced by market-moving news – in the interest of the broker, but against the interest of your profit margin.

Much luck!

 

frequently asked Questions

What is a pip?

 
One pip equals one point in percent.

FX traders use pip to express the tiniest change in rate among two currencies. This is signified by a single figure movement in the fourth number place in a typical forex quote.

The bigger the spread, the bigger the pip and the higher the cost to the trader!

Why do spreads widen?

 
Spreads widen due to lack of liquidity, and the latter is happening due to larger price fluctuations, cancellation of limit orders and lack of market orders by market participants.

This causes market makers in their pricing competition to also widen their spreads to reduce the risk of loss when executing orders.

What are typical spreads and how are they determined?

Spreads vary from broker to broker depending on these factors: market volatility, political uncertainty, breaking news, key economic indicators, lack of liquidity. In general it can be said that no typical spreads exist. Be sure to check with your broker about the spreads they use for currency transactions.

What is a foreign exchange rate?

A foreign exchange rate is the rate of one domestic currency against another currency. It compares the value of one currency to the value of another. This happens in pairs. These rates change over time due to factors affecting currency prices, such as economic news.

Do spreads represent better execution?

 
While spreads can be a determining factor in which broker you choose, that doesn't mean they represent good execution quality. It is important to read broker reviews and testimonials and test their system to judge its execution.

 WHAT IS A PIP IN FOREX?

In forex trading, a pip is a unit of measurement used to express the change in value between two currencies. The term "pip" stands for "percentage in point" or "price interest point," and it represents the smallest possible increment by which a currency pair can change.

The rate of a pip differs depending on the money pair being traded and the lot size of the trade. For example, in a standard lot (100,000 units) of the EUR/USD currency pair, one pip is worth $10. However, in a mini lot (10,000 units), one pip is worth $1, and in a micro lot (1,000 units), one pip is worth 10 cents.

To understand how pips work in forex trading, let's look at an example. Suppose you are trading the EUR/USD currency pair, and the current exchange rate is 1.2000. If the exchange rate moves to 1.2001, this represents a change of one pip. Similarly, if the exchange rate moves to 1.1999, this represents a change of one pip in the opposite direction.

Pips are important in forex trading because they help traders calculate their potential profits or losses. For example, if you buy the EUR/USD currency pair at 1.2000 and the exchange rate moves to 1.2010, this represents a gain of 10 pips. If you are trading a standard lot, this translates to a profit of $100 ($10 per pip).

On the other hand, if the exchange rate moves against you and drops to 1.1990, this represents a loss of 10 pips. Again, if you are trading a standard lot, this translates to a loss of $100.

In conclusion, pips are a crucial aspect of forex trading as they allow traders to calculate their potential profits and losses. Understanding how pips work and how to calculate them is essential for successful forex trading. It's important to remember that forex trading involves risk, and it's crucial to have a disciplined approach and manage your risk carefully.

 WHEN TO BUY OR SELL A CURRENCY PAIR

Knowing when to buy or sell a currency pair is a critical aspect of forex trading. Buying and selling currency pairs involves making predictions about future price movements, and as a forex trader, you need to be able to identify the best opportunities to enter and exit trades. Here are some tips to help you know when to buy or sell a currency pair:

 1. Analyze the Market: To know when to buy or sell a currency pair, you need to analyze the market. This involves looking at a range of factors, including economic indicators, political events, and market sentiment. For example, if the economic data suggests that a particular currency is likely to strengthen, you might consider buying that currency pair.

 2. Use Technical Analysis: Technical analysis is another useful tool for identifying when to buy or sell a currency pair. Technical indicators, such as moving averages, can help you identify trends in the market, while support and resistance levels can indicate potential entry and exit points for trades.

 3. Identify Key Levels: Key levels, such as support and resistance levels, can be useful for identifying when to buy or sell a currency pair. For example, if a currency pair is approaching a key resistance level, you might consider selling it, as this could indicate that the price is likely to reverse.

 4. Use Stop Losses: Stop losses are an essential tool for managing risk when buying or selling currency pairs. A stop loss is an order that automatically closes a trade if the price moves against you. By using stop losses, you can limit your potential losses and protect your capital.

 5. Follow Your Trading Plan: To know when to buy or sell a currency pair, you need to have a clear trading plan. Your trading plan should outline your trading strategy, including your entry and exit criteria, risk management strategy, and target profits. By following your trading plan, you can avoid making impulsive decisions and improve your chances of success.

In conclusion, knowing when to buy or sell a currency pair is a critical aspect of forex trading. By analyzing the market, using technical analysis, identifying key levels, using stop losses, and following your trading plan, you can improve your chances of making profitable trades. Remember, forex trading involves risk, and it's essential to have a disciplined approach and manage your risk carefully.

HOW TO MAKE MONEY TRADING FOREX

FX trading is the act of purchasing and selling currencies to make a revenue. While forex trading can be highly profitable, it can also be risky and requires a great deal of skill, knowledge, and discipline. In this article, we will discuss some tips and strategies for making money trading forex.

Understand the Basics

1.    Currency Pairs: In forex trading, currencies are traded in pairs. For example, the EUR/USD pair signifies the euro against the US dollar. When you purchase a money pair, you are purchasing the base money and selling the quote money.
2.    Bid-Ask Spread: The bid price is the price at which you can sell a currency pair, while the asking price is the price at which you can buy it. The variance among the offer and ask rates is identified as the spread.
3.    Leverage: Forex trading allows you to trade on margin, meaning you can control a large position with a small amount of capital. But, leverage can also increase your losses, so it is essential to use it wisely.
4.    Trading Platform: A trading platform is software that you use to place trades and monitor your positions. There are many different platforms available, and you should choose one that suits your needs and preferences.
5.    Fundamental Study: This includes studying financial, social, and governmental factors that may distress the worth of a currency. For example, interest rate decisions, economic data releases, and geopolitical events can all impact currency prices.
6.    Technical Analysis: This includes using charts and technical indicators to classify trends and patterns in currency prices. Technical study can help you to classify potential entry and withdrawal points for trades.
By understanding these basic concepts, you will be better equipped to start trading forex. However, it is important to continue learning and developing your skills to become a successful trader.

Develop a Trading Plan

Developing a trading plan is important to becoming a effective FX trader. Here are some steps to help you create a solid trading plan:
1.    Set Goals: Before you start trading, it is important to define your goals. This could be a certain amount of profit you want to achieve, a percentage return on investment, or a specific number of trades per day. Having strong goals will support you stay focused and motivated.
2.    Define Your Trading Style: There are many different trading styles, such as scalping, day trading, swing trading, and position trading. You should choose a trading style that suits your personality and lifestyle.
3.    Choose Your Timeframe: Forex traders can trade on a variety of timeframes, from minutes to months. You should choose a timeframe that suits your trading style and goals.
4.    Determine Risk Tolerance: You should determine how much risk you are willing to take on each trade. This will depend on your account size, trading style, and personal preferences.
5.    Identify Entry and Exit Points: You should use technical and/or fundamental analysis to identify potential entry and exit points for trades. This could involve using support and resistance levels, trend lines, or other technical indicators.
6.    Manage Your Trades: You should have a plan for managing your trades, including setting stop-loss and take-profit orders. You should also have a plan for adjusting your trades if market conditions change.
7.    Keep a Trading Journal: Keeping a trading journal can help you track your progress and identify areas where you need to improve. You should record all of your trades, including the reasons for entering and exiting each trade, as well as any lessons learned.
By following these steps, you can create a trading plan that suits your goals and trading style. However, it is important to review and adjust your plan regularly based on your performance and changing market conditions.

Manage Risk

Use Technical Analysis

Keep a Trading Journal

Conclusion

Making money trading forex is not easy, but it is possible with the right knowledge, skills, and discipline. By understanding the basics of forex trading, developing a solid trading plan, managing risk, using technical analysis, and keeping a trading journal, you can increase your chances of success in the forex markets. Remember to always do your research and practice sound risk management techniques, and never trade with money that you cannot afford to lose.

 HOW TO TRADE FOREX

It is a decentralized market, meaning that it is not located in a single physical location but rather consists of a global network of banks, financial institutions, and individual traders who buy and sell currencies electronically. In this article, we will explore the basic steps involved in trading forex.

Step 1: Understand the Forex Market

Beforehand you start buying and selling forex, it's essential to recognize the essentials of the marketplace. This includes knowing what currency pairs are, how they are quoted, and how the exchange rates are determined. Additionally, you should be familiar with the different types of forex trading strategies and the risks involved in trading.

Step 2: Choose a Broker

To trade FX, you need to open an account with a FX agent. A FX agent is a enterprise that provides traders with entree to the FX marketplace. When choosing a broker, you should consider factors such as the broker's reputation, the trading platform they offer, and the fees they charge.we will discuss some key factors to consider when choosing a broker in forex.

        Regulation and Security

The first thing to consider when choosing a forex broker is whether the broker is regulated by a reputable financial authority. Regulatory bodies such as the Financial Conduct Authority (FCA) in the UK, the National Futures Association (NFA) in the US, and the Australian Securities and Investments Commission (ASIC) ensure that brokers operate in a transparent and fair manner, and that client funds are kept in segregated accounts. Choosing a regulated broker is crucial for ensuring the safety of your funds and protecting your rights as a trader.

        Trading Platform

The trading platform is the software that you will use to access the forex market and execute trades. It is important to choose a broker that offers a user-friendly and reliable trading platform that suits your trading style. Many brokers offer popular trading platforms such as MetaTrader 4 (MT4) and MetaTrader 5 (MT5), which offer advanced charting tools, technical analysis indicators, and other features that can enhance your trading experience.

        Spreads and Fees

Forex brokers make money by charging spreads and fees on trades. The spread is the difference between the buy and sell price of a currency pair, and it can vary widely between brokers. When choosing a broker, you should compare their spreads and fees to ensure that you are getting a fair deal. You should also consider other fees such as commissions, account maintenance fees, and withdrawal fees.

        Customer Service

Good customer service is essential when it comes to choosing a forex broker. You want to be able to contact your broker easily and get quick and helpful responses to any questions or issues that you may have. Look for brokers that offer multiple channels of communication, such as phone, email, and live chat, and that have knowledgeable and responsive customer support teams.

        Account Types

Forex brokers offer different types of trading accounts to cater to different trading needs. For example, some brokers offer mini accounts that allow traders to trade smaller lot sizes with lower minimum deposits. Other brokers offer premium accounts that come with extra features such as lower spreads, higher leverage, and personalized customer support. When choosing a broker, consider which account type is best suited to your trading style and budget.

Step 3: Fund Your Account

After choosing a broker, you need to fund your trading account. Most brokers allow traders to fund their accounts using a variety of payment methods, such as credit cards, bank transfers, and e-wallets.

Step 4: Choose a Trading Platform

Most forex brokers offer their own trading platforms, which are software programs that allow traders to execute trades and access market information. When choosing a trading platform, you should consider factors such as ease of use, features, and customization options.

Step 5: Analyze the Market

There are two major types of examination: technical-analysis and fundamental-analysis. Technical analysis involves using charts and other technical indicators to identify trading opportunities, while fundamental analysis involves analyzing economic and political events that may affect currency prices.

Step 6: Open and Close Trades

Once you have analyzed the market and identified a trading opportunity, you can open a trade. To do this, you need to select the currency pair you want to trade, choose the amount you want to trade, and decide whether you want to buy or sell. When you are ready to close the trade, you simply need to reverse the transaction.

Step 7: Manage Your Risk

Handling your threat is an important part of FX trading. One way to do this is to use stop-loss orders, which are instructions to close a trade if the price moves against you. You can also use limit orders, which are instructions to close a trade if the price reaches a certain level of profit.

Conclusion

Trading forex can be a rewarding and exciting activity, but it also involves risks. To be successful, you need to have a solid understanding of the market, choose a reputable broker, analyze the market, and manage your risk.