Forex spread
Forex spread is one of the main forex terms. Like many others financial commodities, here is selling (“bid”) as well as buying (“offer” or “ask”) exchange rate. This difference is well known as “the spread” or “bid-offer spread” - you can see it somewhere like this.
This main forex term is written in a particular format, let’s take for example GBP/USD = 1.5545/50, which means that the bid price of GBP is 1.5545 USD and the offer price is 1.5550 USD. Looks simple, right? And the spread in this example is just 5 points. Every single order of this base currency implies a sale of the secondary currency. Likewise, sale of the base currency implies the simultaneous purchase of the secondary currency. Should we take another one: If you sell GBP/USD, then you simply sell GBP and buy USD. And the opposite: when buying GBP, at the same time you are selling USD.
We can express this equivalence by inverting the GBP/USD exchange rate and rotating the bid and offer reciprocals to derive the USD/GBP rate. For example, if GBP/USD = 1.5545/50 then USD/GBP = 1/1.5550 (bid)/(1/1.5545 (offer) = 0.6431/33
The “lot” is well known as the basic unit of trading for private investors, which represents 100,000 units of the base currency. Some brokers permit trading in mini-lots.
• The sale of a single lot of GBP/USD at 1.5847 entails the sale of 100,000 for 158,470 USD.
• The purchase of a single lot of GBP/USD at 1.5852 implies 100,000 GBP bought at 158,520 USD.
Brokers make their money thanks to the spot forex trading spread. The end result is that you have to pay more when you buy and get less when you sell, which makes it more difficult to realize a profit. Wider spreads will result in a higher asking price and a lower bid price.
They (brokers) don’t earn the full spread, especially when they hedge client positions. This spread helps them to compensate for the market maker for taking on risk from the time it starts a client trade to when the broker’s net exposure is hedged (which could possibly be at a different price).
Some other brokers have different spreads for different clients based on their accounts. For example; those clients that have larger accounts or those who make larger trades may receive tighter spreads, while the clients that are referred by an introducing broker might receive wider spreads in order to cover the costs of the referral. Some offer the same spreads to everyone.
Problems can come up when you are trying to learn about a company’s spread policy because this information, along with information on trade execution and order-book depth is rather difficult to get. Because of this, many traders get caught up in all of the promises they hear, and take a broker’s words at face value. This can be dangerous. The only real way to find out is to try out various brokers or talk to those who have.
Spreads are tighter when there is good market liquidity but they will widen as liquidity dries up. When it comes to choosing between fixed and variable rates, the choice depends on your individual trading pattern. If you trade primarily on news announcements that you hear, you may be better off with fixed spreads. But only if quality of execution is good.
Spot forex trading spreads are important because they affect the return on your trading strategy in a big way. As a trader, your sole interest is buying low and selling high (like futures and commodities trading). Wider spreads means buying higher and having to sell lower. A half-pip lower spread doesn’t necessarily sound like much, but it can easily mean the difference between a profitable trading strategy and one that isn’t profitable.
Spread policies change a great deal from broker to broker, and the policies are often difficult to see through. This certainly makes comparing brokers much more difficult. Some brokers actually offer fixed spreads that are guaranteed to remain the same regardless of market liquidity. But since fixed spreads are traditionally higher than average variable spreads, you are paying an insurance premium during most of the trading day so that you can get protection from short-term volatility.
Spot forex trading spreads are important because they affect the return on your trading strategy in a big way. As a trader, your sole interest is buying low and selling high (like futures and commodities trading). Wider spreads means buying higher and having to sell lower. A half-pip lower spread doesn’t necessarily sound like much, but it can easily mean the difference between a profitable trading strategy and one that isn’t profitable.
Other brokers offer traders variable spreads depending on market liquidity. Spreads are tighter when there is good market liquidity but they will widen as liquidity dries up. When it comes to choosing between fixed and variable rates, the choice depends on your individual trading pattern. If you trade primarily on news announcements that you hear, you may be better off with fixed spreads. But only if quality of execution is good.
In summary, the spread is the difference between the price that you can sell currency at ( Bid ) and the price you can buy currency at ( Ask ). The spread on majors is usually 5 pips under normal market conditions. A pip is the smallest unit by which a cross price quote changes. When trading forex you will often hear that there is a 5-pip spread when you trade the majors. This spread is revealed when you compare the bid and the ask price, for example EUR/USD is quoted at a bid price of 0.9875 and an ask price of 0.9880. The difference is USD 0.0005, which is equal to 5 “pips”.
You know that the EUR/USD is quoted with four decimals, so all you have to do is the cancel-out the four zeros on the amount you trade and you will have one pip. Thus, on a EURUSD 100,000 contract, one pip is USD 10. On a USDJPY 100,000 contract, one pip is equal to 1000 yen, because USDJPY is quoted with only two decimals. On a contract or position, the value of a pip can easily be calculated.