Today, I am going to cover one of the most important topic in Forex, spread. Like leverage spreads are also very important that you shouldn’t start trading before learning it. So are you eager to learn it? Let’s begin quickly!
How is forex spread calculated? How shouldn’t you calculate spread? What is the meaning of spread in Forex? Continue reading for getting answers of all these information.
- 1 What is spread in Forex?
- 2 Why spread is applied?
- 3 How to calculate spread?
- 4 How to avoid high spreads?
What is spread in Forex?
All the markets have spread and Forex (Foreign Exchange) isn’t an exception. Forex spread meaning can be explained as difference of price when you want to buy or sell.
Before diving into details I have to mention that there is a synonym word for this difference. It’s called bid-ask spread.
‘Bid’ means the exchange ratio that is applied for a customer who is willing to buy with highest price. ‘Ask’ means the lowest price that a currency pair for sale. Be aware! Bid must be lower than Ask.
Spread means the difference between them and there are three types of spreads.
If the difference between Bid and Ask remains constant, it falls to this fixed spread category. Automatically traded accounts use these fixed spreads.
Fixed Spread with an Extension
Spread is partly declared and the dealer determine the rest according to market conditions.
The spread completely moves by market. In this type of spread, fluctuation of market is crucial. If the market prices change so fast, the spreads are widens. In contrast, if the market is relatively stable, low spreads are applied.
Why spread is applied?
The third party who meets buyer and seller have responsibilities. He has to ensure the flow in order of the currencies. So firstly, he has to find a buyer and a seller. This costs money!
Moreover, assume that he accepts the bid, what if the currency value increases before he finds a seller? He has to pay the gap and realize the trading execution. It means risk taking and he has to take certain amount of money to counter this risk.
So spreads exist for these reasons.
How to calculate spread?
Suppose that 1.14411 is the bid price of EURUSD. It’s the price that market wants to buy. Meanwhile market wants to sell the base currency as 1.14419 for USD as counter currency.
So if we subtract bid price from ask price, we get the spread.
In this case 1.14419-1.14411=0.00008. This means 0.8 pips
So let’s explain the pips.
What is a pip in Forex?
Price Interest Point is the expansion of the pip. A pip is the smallest unit and it measures price movements in parities.
Pip is the fourth decimal value that indicates the changes in exchange rates.
For more detailed information, you may read our comprehensive article about pips.
How to calculate Costs?
The total cost of the spread can be calculated by this equation:
Costs = Spread x Pip Cost x Number of lots
How to avoid high spreads?
Importance of Forex Marketing Hours
Forex is the biggest market if we compare with others. Thus one can find a buyer regardless of what you sell. As a result high liquidity realized.
When more people make trading executions, liquidity increases. But when do people trade more? What is the best forex market hours?
Most people think that best market hours are when two trading sessions overlap. It seems logical in theory. But in practice overlap of Asian-European session is quite boring and low volume compared to Overlap of European – North American Session.
At this overlap, trading is getting exciting! This time frame is the most dynamic of all day.
Also crucial news from United States and Canada during the early times of their local time. This also affects trading trends very strongly. since the United States is still the only superpower in the world and economy of Canada is quite related to United States.
You can get a detailed perspective in our Forex market hours article.
Importance of Trading Currency
If you want to trade with low spreads, trade with currencies of high liquidity. Because the more popular currencies, the more Forex companies offer trading with these currencies. That means competition! During this competition, companies are happy with the tight spreads because of big trading volume. They can make good profit even with smallest pips. Thus spreads tightens.
Liquidity also play an important role here.
Top 10 most common trading currencies are the U.S. dollar or USD ($) , the euro or EUR(€), the Japanese yen or JPY(¥), the British pound or GBP (£), the Australian dollar or AUD (A$), The Canadian dollar or CAD (C$), the Swiss franc or CHF (Fr), Chinese Yuan or CNY (元), the Swedish krona or SEK (kr) and the New Zealand dollar or NZD (NZ$).
Try to trade with these currencies in order to avoid high spreads. But be careful, just because these currencies are so common, It doesn’t necessarily mean that every possible combination of pairs are suitable.
For example while USDCAD pair can be considered as good option, CHFNZD isn’t very smart choice.
Comment below about the article or spreads in general. Your valuable opinions matter to us!