Understanding the fundamentals of forex trading will greatly improve your trading experience. One area of knowledge that many new traders find complex is what is known as the “spread” in forex trading.
The spread is a term used to describe the difference between an asset's ask and bid prices – but what does this mean in practice?
In this blog post, we'll look at exactly what a spread is and how it affects trades in different markets.
We'll then discuss strategies you can use to limit its impact on your wins and losses when trading on financial markets.
By the end of the reading, you should have a clearer understanding of spreads, allowing you to make more informed decisions for successful forex trade.
What Is Spread?
In forex trading, a spread refers to the difference between a currency pair's bid/ask price. The bid price is the price at which a trader is willing to buy a currency, while the ask price is the price at which a trader is willing to sell a currency.
The spread is typically expressed in pips, which is the smallest unit of price movement in the forex market.
For example, if the bid price for the EUR/USD currency pair is 1.1750 and the ask price is 1.1753, the spread would be 3 pips. This means that a trader would have to pay an additional 3 pips above the current market pricing in order to buy the EUR/USD pair.
On the other hand, a trader who wants to sell the EUR/USD pair would receive 3 pips less than the current market exchange rate.
The spread size can vary depending on several factors, including the liquidity of the currency pair, the time of day, and the broker or market maker offering the quotes.
In short, more liquid currency pairs tend to have smaller spreads, while less liquid pairs tend to have larger spreads.
What Is The Difference Between Fixed and Variable Spread
A fixed spread is a spread that does not change, regardless of market conditions or the time of day. This means that the difference between a currency pair's bid and ask price is always the same.
A variable spread (Floating Spread), on the other hand, is a spread that can change based on market conditions. This means that the difference between a currency pair's bid and ask price can fluctuate over time.
Variable spreads tend to be wider during times of high market volatility or low liquidity and narrower during times of low volatility or high liquidity.
Some forex brokers offer fixed spreads, while others offer variable spreads. It's important to understand the difference between these two types of spreads and how they can impact your trades.
Fixed spreads may be more predictable, but they may also be wider than variable spreads during times of low volatility.
Conversely, variable spreads may be more unpredictable, but they may also narrower during low volatility.
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How Is Spread Calculated In The Forex Market?
Knowing how to calculate spread in the forex market is an important skill for any trader. Traders can determine spread by subtracting the ask price from the bid price of a particular currency pair, as this will give them their exact spread.
Although the spread can vary depending on the currency pair being traded, it's usually quite small.
For example, for major pairs such as EUR/USD, it could range from 0.0 pip to 1.5 pips – a tiny fee when compared to other trading markets.
When using non-dealing desk (NDD) broker, it does not act as a market maker and does not take the opposite side of a trade.
Instead, NDD brokers provide access to the interbank market through STP (Straight Through Processing), where traders can buy and sell currencies directly with other market participants.
Hence, the spread is typically wider than with dealing desk brokers who utilize ECN (Electronic Communications Network), as NDD brokers do not have the ability to set the spread themselves.
They just pass on the spread they receive from the interbank market to their clients.
What Does A Forex Spread Tell Traders?
Traders use Forex spreads to measure the difference between the bid and ask prices in a currency pair.
This measurement is used to determine if a currency pair is expensive or inexpensive based on the cost of buying or selling it.
Forex spreads indicate the liquidity of a currency pair, as well as its volatility. They can also be used as an indicator of market sentiment and help traders decide when to open and close trades.
By understanding what a forex spread tells traders, you can better identify opportunities for profitability in your trading activities.
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What Determines Spread In Forex?
Several factors can influence spread in the forex market:
Liquidity: More liquid Currency pairs tend to have smaller spreads, as more buyers and sellers are willing to transact at any given time. Less liquid pairs tend to have larger spreads, as there are fewer participants in the market.
Volatility: During times of high market volatility, spreads may be wider as the risk of price movements increases. During times of low volatility, spreads may be narrower.
Time of day: The spread may also vary depending on the time of day. For example, spreads may be wider during times of low liquidity, such as during the weekend or overnight, when the forex market is closed.
Broker or market maker: The spread can also be influenced by the broker or market maker offering the quotes. Some brokers may offer tighter spreads, while others may offer wider spreads.
Transaction cost: The spread can also be influenced by the cost of trading, including the cost of executing trades, financing, and any other fees associated with trading.
Economic and political events: Economic and political events can also impact the spread. For example, if a significant news event or policy change affects the currency market, it can lead to increased volatility and wider spreads.
What is Scalping As A Spread Strategy?
Scalping is a trading strategy that involves making multiple trades over a short period, intending to profit from small price movements.
In the context of spread trading, scalping can refer to a strategy where a trader aims to make a margin from a slight difference between the bid and ask price of a currency pair.
To scalp the spread, a trader may open and close positions very quickly, often within seconds or minutes.
The trader may aim to profit from small changes in the spread, either by buying at the bid price and selling at the ask price or by selling at the bid price and buying at the ask price.
Scalping strategies can be risky, as they rely on executing trades quickly and accurately to profit from small price movements.
Scalping can also be more difficult in a low-volatility market, as the potential for price movement may be limited.
Take Away
Overall, understanding the spread is an essential part of forex trading, as it can impact a trader's cost and potential profitability. The spread is one of the main transaction costs of trading in the forex market.
It represents the difference between the price at which a trader can buy a currency and the price at which they can sell it.
By understanding the potential impact of the spread on a trade, a trader can better manage their risk and adjust their trading strategy accordingly. It can also be a factor to consider when selecting a forex broker for transparency in the execution of spreads.
Some brokers may offer fixed spreads, while others may offer variable spreads.
Forex reading isn't difficult as long as you understand what its all about, staring with the basics. So, what are you waiting for? Get started today by reading our the following in the Forex Education Section
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