Forex trading is full of complicated terminologies. Surprisingly, beginners are not the only ones who face confusion understanding these terms. Some experienced people in the foreign exchange landscape also face trouble comprehending some jargon. Spread is a well-known word that quite a lot of forex traders have trouble understanding. Here we will discuss its meaning and other information associated with it.
What is spread in forex?
Ordinarily, the term "spread" means to extend or lay something out. However, its meaning in the forex world is vastly different. Spread is the variance between the asking price (also referred to as the buy price) and bidding price (known as the sell price) of a particular currency pair.
You will always find two prices in a currency pair: the ask price and the bid price. The price you can sell the base currency is the bid price. On the other hand, the ask price is the amount used to purchase the base currency.
The base currency is the first one in the currency pair (left side), whereas the counter, quote, or term currency is the second one (right side). This enables you to determine how much a single unit of base currency equals in the term currency. Remember, the quote for the buy price will always be higher than the selling price, with the underlying price of the market somewhere in the middle.
Ordinarily, experts trade forex currency pairs without any commission. However, there is a spread’s cost applied to virtually every trade. Instead of charging commissions, every leveraged trading provider incorporates a spread to the trade's value.
Several factors influence the spread, the most significant being volatility, the currency pair and your trade size. The provider you are using also makes a massive difference. At FxPro we offer competitive spreads on all account types, or we have the cTrader account which has much lower spread but a separate commission charge.
Here are some of the major forex pairs:
What does Spread mean?
Experts use pips to measure spread. If you are not yet aware, pips are a small unit of movement in a currency pair's price. They typically represent the fourth digit after the decimal point in a price quote. This stands true for most currency pairs except the Japanese yen and a few others. In the Japanese yen, the pip is the second digit after the decimal point. (Bear in mind that many brokers, including FxPro, will quote the price to an extra digit after the Pip, which is referred to as a ‘point’).
When there is a more significant difference between prices, it means the spread is higher. In this case, it usually means liquidity is mostly low, while the volatility is high. On the other hand, a lower spread highlights high liquidity and low volatility. Therefore, the highly liquid pairs such as forex majors will typically have tighter spreads and as such, a lower cost to trade.
Variable and Fixed Spreads
Commonly, traders pay spreads without knowing how much they cost. These costs add up and become quite significant so this is something to consider when selecting a forex broker.
Mostly, foreign exchange brokers offer two spread types: fixed or variable. Aspiring traders reading this might be wondering which option is the best. Well, there is no black and white answer to this question. Experts have varying opinions on this topic. Additionally, trading styles are also massive determinants of which spread type may be better. This is why at FxPro we offer mostly floating spreads but with a specific fixed spread option for those who wish to utilise fixed spreads. Let’s take a detailed look at these spread structures:
With this spread type, the difference between a particular currency pair’s buying and selling price fluctuates often. Variable spreads for the Euro and U.S Dollar will generally have a difference around one to four pips. However, things can be vastly different if the market is volatile, and the spread could become as wide as eight to ten pips, depending on the market conditions.
A variable spread will get tighter in connection with improved market liquidity but if the market is inactive for a significant period, it may become wider.
Unlike variable spreads, fixed spreads remain predetermined. They stay constant according to the broker’s structure. A fixed spread often falls within the range of a variable spread. For example, with the FxPro MT4 Fixed account, Euro and United States Dollar pairing is 1.6pips during the daytime hours.
Fixed spreads allow traders to strategise more efficiently without considering unpredictable variables responsible for inflating transaction costs. So this can come in quite handy, especially during critical periods for traders.
How to calculate Spread in Forex?
Calculating forex spread cost is not as complicated as most aspiring traders believe. Let’s carefully analyse how to calculate the spread. Traders always receive forex quotes with bid and ask prices, similar to equity markets. As discussed earlier, the bid constitutes the price that the foreign exchange market maker is willing to give for the base currency by providing the counter currency in return.
Conversely, the price that a forex market maker decides to give away the base currency by exchanging it for the counter currency will be the asking price. You will typically find forex prices quoted in five digits. For instance, if we had a U.S Dollar/ Canadian Dollar bid price around 1.35600 with a 1.35650 asking price. The spread for this will be equal to 0.0005 (5 pips), which is then multiplied by your trade size.
Forex Spread indicators
A spread indicator can be a useful tool among forex traders. It displays the difference between the bid and ask prices of an asset, currency, or security. People often use spread indicators on their charts to see a graphical representation and it is something that many forex traders swear by. Some spread indicators display the spread in a graphical curve, whereas others simply display the live spread on the chart in pips. As mentioned previously, currency pairs with high liquidity typically have low spreads.
To calculate spreads you need to determine the difference between ask and bid prices, which can be very cumbersome to do manually especially when dealing with very fast changes in quotes with several decimals. You will find plenty of different FX spread indicators online and can select a user-friendly option to ensure that your trading experience is hassle-free. Some platforms have such indicators built-in.