In order to be successful in forex trading, every trader needs to understand the concept of spread. What is spread, how does it work, and what impact does it have on your trading?
This article will provide you with all the information you need to know about forex spread. Let’s start our discussion.
What is Spread in Forex?
We need to understand the forex spread meaning first.
In Forex and other markets, the spread is the difference between the purchase and sale prices of an asset. With online brokers, spreads are always higher than purchase prices for assets – meaning that if you opened a position and closed it straight away, you would make a loss exactly equal to the spread.
In order to start making a profit with online brokers, the market needs to move in your favor by an amount equivalent to or more than the spread. Spreads can be fixed or variable but most brokerages offer variable spreads nowadays.
How to Calculate it?
To calculate the spread in forex, you need to determine the difference between the buy and the selling price. This is done by subtracting the bid price from the asking price. For example, if you are trading GBP/USD at 1.3089/1.3091, then the spread would be calculated as 1.3091 – 1.3089, which is 0.0002 (2 pips).
A spread is a measure of how far apart 2 prices are. The wider the spread, the more expensive it is to trade between those two prices. Traders often prefer tighter spreads, as they make trading less expensive.
Let’s get acquainted with high and low spreads closer.
High spread
When a currency pair has a high spread, it means that the difference between the bid and ask prices is large. This is generally true for pairs involving emerging market currencies instead of major currencies.
When the difference between the prices of a security and the price at which it can be sold is high, this usually means that either the market is very volatile or there are not many people who want to buy it.
Low spread
When the spread is low, it's a good time to trade because that means the difference between what people are willing to pay (the bid price) and what people are asking for (the asking price) is small. This happens during major Forex sessions when volatility is low and liquidity is high. Low spread is also called ‘’tight’’ in terminology. Check tight spread forex brokers if you want to trade with professionals.
Factors that Determine Spread in Forex
The spread is determined by a number of factors, including the liquidity of the asset being traded, market conditions, and volume traded. The more an asset is traded, the more liquid its market becomes. The smaller or ‘’tighter’’ the spreads are in a liquid market. However, in markets with low liquidity (or ‘’thin’’ markets), the spreads tend to be larger.
The forex spread widens during periods of high market volatility, which can be due to an important news announcement or another event. This can negatively impact your positions if the spread becomes too large. It is important to stay updated on upcoming financial events using the economic calendar brokers offer.
Check out the Xtrade review as one of the reputable brokers in the industry.
What is Spread Trading Strategy?
Let’s talk a little bit about spread trading strategy as well. What is it?
Well, in a nutshell, it is a way of trading that involves buying one security and selling related security at the same time. The securities being bought and sold are typically executed through futures contracts or options, though there are other types of securities that can be used.
When you spread trade, you are trying to get a net position worth a certain amount. This amount will be based on the difference in prices between the two securities you are selling. Usually, you won't trade these securities separately. Instead, you'll trade them as a unit on futures exchanges.
Conclusion
To wrap it up, forex spreads are the main cost of trading in the foreign exchange market for retail traders. The concept is not complicated, but each trader must understand it as it has a major impact on your overall costs and profits.
Aidan has been writing about personal finance for over 6 years. Prior to this, he worked as a Corporate Finance Analyst where he specialized in Due Diligence, Company Valuations and more. He is a CFA charterholder.
