Spread in Webster’s dictionary means expanding over a larger area, but what is spread in forex? The term “spread” refers difference between the bid price (the price at which a trader can sell a currency pair) and the ask price (the price at which a trader can buy the same currency pair). The spread essentially represents the transaction cost of entering a trade, and it is a fundamental concept that traders need to learn for effective decision-making.
Today we’ll answer: What is spread, and explore how it operates in the context of forex trading. Explore various spread types, including raw, zero, and half spreads along with related terms such as pip and leverage. Examine the benefits and identify the two primary spread configurations traders encounter: floating spread and fixed spread. We’ll also learn the concept of spread betting and how to engage in it in a profitable way.
In addition, we will also observe forex live spreads to gain practical insights into their real-time fluctuations. Learn how to calculate spreads, as it enables you to assess the cost of executing a trade effectively. You’ll also learn how you can incorporate spread calculations into risk management and strategies.
What is Spread in Forex?
The spread in forex, is the margin between the buying and selling prices. This differential serves as the means through which brokers generate revenue and profit. Some brokers, such as Exness, provide zero and raw spread accounts, which can be advantageous in minimizing your expenses. You can also check my low spread forex brokers list.
Let’s say that you are focusing on the EUR/USD currency pair, which is one of the most traded pairs globally. It’s a typical day with stable economic conditions, and the market is relatively calm.
In this scenario:
- The bid price for EUR/USD is 1.1050.
- The ask price for EUR/USD is 1.1055.
The spread, in this case, would be 5 pips (1.1055 – 1.1050). The relatively tight spread indicates a stable market with high liquidity for this major currency pair. As a trader, you might find that the cost of entering and exiting positions is lower due to the narrow spread, providing a favorable environment for executing trades.
Now, let’s shift to a scenario where a significant economic event is unfolding, causing increased volatility in the market.
Imagine, a crucial economic report is about to be released, and traders anticipate a substantial impact on the USD. You’re trading the USD/JPY currency pair.
In this scenario:
- The bid price for USD/JPY is 109.80.
- The ask price for USD/JPY is 109.85.
However, as the economic report is released, market uncertainty and rapid price movements lead to an increase in volatility. The bid price quickly drops to 109.70, while the ask price rises to 109.95.
The spread has now widened to 25 pips (109.95 – 109.70). This widening of the spread reflects the market’s uncertainty and the increased risk associated with executing trades during volatile periods. Traders need to be mindful of such scenarios, as wider spreads can impact the overall cost and risk of their trades.
In both scenarios, these real-world examples highlight the dynamic nature of spreads in Forex trading. You must navigate different market conditions, understanding how spreads fluctuate and impact the overall cost of engaging in the foreign exchange market. The ability to adapt to varying spreads is a crucial skill if you want to be successful in forex trading.
Lower the spread better the trade for you, and you should choose the brokers that offer lowest spreads.
What is a pip in Forex?
“Price Interest Point” known commonly as the pip is the forth decimal number value that represents the change in the exchange rates. A pip is the measuring unit of the spread and its the smallest unit.
A pip in forex is equivalent to one-hundredth of one percent, or 0.01%, of a single unit. Moving from 1.0003 to 1.0004 would constitute a one-pip change.
To put it mathematically: 1 Pip = (1/100) * 0.01
For more detailed information, you can read Pips.
Understanding what spread means is crucial for forex traders to optimize strategies and manage costs effectively. In this section we’ll dive into the concepts of fixed spreads, variable (floating) spreads, raw spreads, and zero spreads, providing you with insights into these different pricing structures.
By understanding the distinctions between these spread types, you can make informed decisions that align with your trading styles, risk tolerance, and overall market expectations.
What is Fixed Spread?
A fixed spread in Forex trading refers to a constant difference between the bid and ask prices, regardless of market conditions. The spread remains stable and does not change, which will allow traders to predict the trading costs easily.
Let’s say that, you’re considering a broker that offers fixed spreads. In this scenario, the difference between the bid and ask prices remains constant, regardless of market conditions.
You’re interested in trading the GBP/USD currency pair with a broker that provides a fixed spread of 2 pips. The bid price is 1.3000, and the ask price is 1.3002.
- Stability: Fixed spreads provide you a stable trading environment, as the cost of entering and exiting a trade remains consistent.
- Predictability: Traders can easily calculate transaction costs, making it easier to manage risk and plan trades.
- Market Conditions: Ideal for traders who prefer a steady, known cost structure and are less concerned with adapting to changing market conditions.
What is Variable(Floating) Spread in Forex?
Variable spreads, also known as floating spreads, refer to spreads that fluctuate based on market conditions. The difference between the bid and ask prices can widen or narrow depending on factors such as market volatility, liquidity, and economic events.
Let’s say that you are considering to trade the GBP/JPY currency pair with a broker that offers variable spreads. In a calm market, the bid price might be 150.00, and the ask price 150.05, resulting in a 5-pip spread. However, during a period of high volatility, the spread might widen to 10 pips (150.10 – 150.00).
- Adaptability: Variable spreads adjust to changing market conditions, providing traders with the flexibility to navigate different environments.
- Market Volatility Impact: Spreads tend to tighten during stable market conditions but may widen during periods of high volatility.
- Potential Cost Savings: Traders may experience lower costs during favorable market conditions but should be aware that spreads can increase during turbulent times.
Fixed Spread vs Floating(Variable) Spread
Spread is one of the most important factors when choosing a forex broker, as it can directly impact your profits. In an ideal world where every broker is reliable, Spread would be among the top three conditions to consider when selecting a forex broker. However, whether to go for fixed spreads or floating spreads is entirely up to you. Here’s what you should consider before choosing between fixed spreads and floating spreads.
- Trading Style: Traders with specific strategies may prefer one type of spread over the other. For example, scalpers who aim for small price movements may favor fixed spreads, while swing traders might be comfortable with variable spreads.
- Broker Selection: Different brokers offer different spread structures. Traders should choose a spread type that aligns with their trading preferences and overall strategy.
- Risk Management: Understanding how spreads impact overall trading costs is crucial for effective risk management. Traders need to factor in spreads when assessing the feasibility and profitability of their trades.
In summary, whether you choose fixed or variable spreads depends on your preferences, trading style, and the specific market conditions you anticipate to be in. Each type has its advantages and considerations, and the choice often comes down to what aligns best with a trader’s overall approach.
The interbank market is a financial network where banks and other financial institutions engage in direct transactions and trading of currencies among themselves.
Raw spread is the difference between the bid and ask prices of a currency pair without including any mark-up or additional broker charges. It represents the purest form of spread, reflecting the interbank market conditions.
In the interbank market, where large financial institutions and banks trade currencies, the spread is determined by the supply and demand for a particular currency pair. Raw spreads are considered the most transparent as they exclude any broker markup or commission.
Let’s say that the EUR/USD has a bid price of 1.1000 and an ask price of 1.1002 in the interbank market. The raw spread in this case would be 2 pips (1.1002 – 1.1000).
What raw spread offers:
- Transparency: Raw spreads will provide a clear representation of the true cost of trading without additional broker charges.
- Direct Market Conditions: Raw spread reflects the actual pricing in the interbank market, the real supply and demand dynamics.
- Broker Commissions: Brokers offering raw spreads often charge a separate commission, making it essential for traders to consider both the spread and commission costs.
Zero spread, as the name goes, refers to situations where the bid and ask prices for a currency pair are identical, resulting in a spread of zero pips. While the idea of a zero spread might sound appealing, it’s important to note that zero spread conditions are rare and typically occur momentarily in a natural fluctuation of a forex market.
Some brokers offer zero spreads as a promotional feature, but it’s crucial for you to understand the underlying conditions before diving in, as there may be additional charges or unjust commissions.
Let’s say that in the ever fluctuating forex market, during a brief moment, the bid price and ask price for a currency pair align perfectly. For instance, if the bid price for EUR/USD is 1.1050 and the ask price is also 1.1050, it means that the spread is zero pips.
What do you need to consider with zero spread?
- Temporary Nature: Zero spread conditions are often short-lived and may not be sustained during active market conditions.
- Broker Promotions: Some brokers offer zero spreads as a promotional feature to attract traders, but it’s important to examine the overall trading conditions, including potential commissions or fees.
- Execution Speed: Achieving zero spread may depend on high-speed order execution, and not all traders may experience this due to various factors.
Which should you choose, zero spread or raw spread?
- Cost Evaluation: Traders should consider both raw spreads and zero spreads along with any associated commissions or fees to evaluate the overall cost of trading.
- Market Conditions: Zero spreads may be more common in less volatile market conditions, and you should be aware that conditions can change rapidly.
- Broker Reputation: When considering brokers offering raw or zero spreads, it’s essential to assess their reputation, regulatory status, and the reliability of their trading platform.
In summary, both raw spreads and zero spreads represent approaches to pricing in Forex trading, with raw spreads you’ll be bound to interbank market conditions while zero spreads offers no margin between and ask and sell prices.
You should carefully examine the overall trading conditions and costs associated with zero spread if you are willing to go that way. There are a few reliable brokers that offer zero spread accounts but some scammers also use this opportunity to trap novice forex traders. I suggest you to read my broker review before dealing with a zero spread broker.
Live Forex Spreads
Live forex spreads reflect real-time market conditions and are subject to constant fluctuations. Live forex spreads can be influenced by various factors, including market liquidity, economic indicators, geopolitical events, and overall market sentiment. During periods of high volatility, spreads tend to widen as uncertainty rises.
How to Calculate Spread Costs?
Calculating forex spread costs involves understanding the difference between the bid and ask prices. The spread cost can be determined using the following formula:
Spread Cost= (Ask Price) – (Bid Price)Spread Cost=(Ask Price) – (Bid Price)
- Ask Price: The price at which you can buy a currency pair.
- Bid Price: The price at which you can sell a currency pair.
Spread in forex means, subtracting the bid price from the ask price, and this value represents the cost associated with entering a trade.
For example, if the EUR/USD currency pair has an ask price of 1.1055 and a bid price of 1.1050, the spread cost would be:
Spread Cost=1.1055−1.1050=0.0005Spread Cost=1.1055−1.1050=0.0005
In this scenario, the spread cost is 0.0005, or 5 pips. This value represents the transaction cost you incur when entering a trade. Keep in mind that spreads can vary across brokers and currency pairs. You can also check my lowest spread forex brokers list.
Factors Influencing Forex Spreads:
1. Market Liquidity and Its Impact on Spreads:
Market Liquidity refers to the ease with which a financial instrument can be bought or sold without causing a significant price change.
In highly liquid markets, where there is a high volume of buying and selling, spreads tend to be tighter. Conversely, in less liquid markets, spreads can widen as it becomes more challenging to match buyers with sellers.
2. Economic Indicators and Spread Fluctuations:
Reports and data releases that provide information about the economic health of a country.
Major economic releases (e.g., GDP, employment data) can create volatility in the Forex market which will lead to spread fluctuations. Traders often experience wider spreads during significant economic events.
3. Broker Policies and Spread Variability:
Each Forex broker has its own policies regarding spreads, commissions, and trading conditions.
Brokers may offer fixed or variable spreads as well as raw and zero spreads and their policies can influence the variability of spreads. You should be aware of their broker’s spread structure and any additional fees that may impact overall trading costs since zero and raw spreads often comes with additional commissions.
You can check my list of brokers with the best spreads or the best brokers not to get affected by additional charges.
4. Economic Releases:
Announcements of key economic data, such as interest rate decisions, employment figures, or inflation reports can cause heightened volatility and wider spreads around the time of economic releases. Rapid price movements can lead to increased uncertainty, influencing bid-ask differentials.
5. Effects of Political Events on Spreads:
Elections, geopolitical tensions, wars and policy decisions can significantly impact a country’s currency and spread values.
Political events means uncertainty and lead to market reactions in both stocks and forex. You may witness wider spreads as market participants adjust to changing geopolitical or policy landscapes.
6. Importance of Forex Marketing Hours
Since Forex is the biggest market in the world due to its high liquidity and volume, that makes it easier to find a buyer for whatever you want to sell.
A high flow of trades automatically means high liquidity and that would also mean higher profits, which is the reason why traders are very keen on knowing the best times for trades. So here’s the question, What’s the best time for more and better trading? and What is the best Forex market hours?
Due to the time differences between different parts of the world where the market headquarters exist, naturally, an overlap will happen between them. But that overlap doesn’t mean that it’s always exciting, as the overlap of the Asian-European markets is quite the bore if compared to the overlap of European- North American markets which is considered the most exciting and interesting overlap of the day as it’s the most dynamic.
News also plays an important role in affecting the markets, especially from the heavy impact from countries like USA and Canada. Not just any news, critical ones may drastically affect the entire balance.
Read more at our Forex market hours article.
7. Importance of Trading Currency
Liquidity plays an important role in affecting the tightness of the spread, as you trade with high liquidity currencies, they allow you the chance to have a low spread while trading because high liquidity means more abundance and thus more competition. And that would make the brokers happily tighten the spreads as the trading volume is increasing spreads lower.
The 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$), the Swiss franc or CHF (Fr), Chinese Yuan or CNY (元), the Swedish krona or SEK (KR) and the New Zealand dollar or NZD (NZ$).
Trading with these currencies would allow you to avoid high spreads. but not every currency pair is common so take caution.
For example while USDCAD pair can be considered as good option, CHFNZD isn’t preferred much.
8. Broker Related Factors: Execution Time and Policies
Each Forex broker has its own policy regarding spreads, commissions, and trading conditions.
Execution time which a broker processes and executes trades, influencing the time it takes to open or close a position hugely effects spread values. Some brokers even manipulate the spread amounts to profit.
Broker policies, such as raw or zero spreads, commission structures, and execution times, can influence the variability of spreads. You should be aware of these factors and learn about the forex brokers before making any trade.
Forex Spread Trading Strategies
Spreads can fluctuate and widen during the times of volatility, which may not be surprising for forex market. High leverage amplifies the cost of trading with amplifying the damage of the spread.
It’s crucial to keep updated on the market to anticipate the fluctuations that may widen the spreads. Sticking with the major pairs like EUR/USD or USD/JPY will keep you safe from the sudden changes in spreads, if your strategy is to be safe before everything.
Trade during the major market sessions are open like London, New York, Sydney, Tokyo. Spreads are generally tighter when several of these centrals are open.
You want to maximize profits while minimizing costs right? Let’s say you choose to trade the USD/JPY, a major currency pair known for its liquidity and low spread.
Before initiating a trade, you check the economic calendar and news that are likely to spike volatility and widen the spread. You decide to execute your trade when the London and New York sessions overlap, taking advantage of the narrower spreads due to high trading volumes.
By combining these spread trading strategies, you’ll effectively manage the spread costs, increase your trading efficiency and profit.
Impact of Spread in Day Trading
Day trading involves buying and selling financial instruments within the same trading day to take advantage of short-term price movements. The bid-ask spread, representing the difference between the buying (bid) and selling (ask) prices of a security, is a crucial factor for day traders.
Intraday traders aim to profit from small price movements. Low spreads minimize transaction costs as traders can enter and exit positions at a smaller cost.
With low spreads, traders can capture more of the price movement as profit, as a smaller portion of the price movement is eroded by the spread.
Intraday traders often use technical analysis and set tight stop-loss orders. Low spreads allow for more accurate entry and exit points.
Spread for Scalping
Low spreads are particularly beneficial for scalpers who execute a large number of trades in a single day. The reduced cost per trade makes frequent trading more viable.
Spread and Order Types
Place limit orders to enter and exit positions at specific price levels. This helps you to execute trades at desired prices, maximizing profit potential.
Algorithmic trading strategies can take advantage of tight spreads by executing a large number of trades automatically. Algorithms can be programmed to respond quickly to market conditions.
Intraday traders often focus on capturing short-term trends. Tight spreads allow for more effective implementation of momentum and trend-following strategies.
With low spreads, day traders can adjust their position sizes more precisely, optimizing the risk-reward ratio for each trade.
Swing Trading and Spread
Swing traders aim to capture price swings over a few days to weeks. Spread costs can impact entry points, so it’s crucial to account for them when identifying optimal entry levels.
Similar to day trading, precise exit points are essential for swing traders. Spreads can affect the realization of profits or the minimization of losses, so traders must consider this when setting exit strategies.
Swing traders often choose securities with sufficient liquidity to ensure that spreads remain relatively tight. High liquidity minimizes the impact of slippage and allows for smoother entry and exit.
Since swing traders hold positions for an extended period, they can adjust position sizes to accommodate spread costs while keeping the individual trades aligned with overall risk management strategies.
Diversifying across multiple positions can help distribute spread costs, especially if some securities have tighter spreads than others.
Balancing spread costs with longer holding periods involves adjusting position sizes, utilizing limit orders, staying informed about market conditions, and adapting strategies to keep spread costs align with the overall risk-return profile of the trades.
What is Spread Betting
Spread betting is a way to make bets on the price movements of financial things like currencies, stocks, or commodities. You can bet on prices going up (called “going long”) or down (called “going short”).
The profit or loss you make is based on how much the actual price moves in the direction you bet. It’s flexible, allowing you to trade various things without actually owning them. In some countries, the profits might be tax-free. However, it involves risks, especially because of leverage, which makes your potential gains or losses bigger.
Let’s say that you believe that the Euro (EUR) is going to strengthen against the US Dollar (USD). You decide to go long on the EUR/USD currency pair using spread betting with FXPro.
You conduct a comprehensive research, analyzing market trends, economic indicators, and news affecting the EUR/USD exchange rate. Based on your analysis, you predict a bullish movement in Euro.
You open an account with a broker that allows spread betting, for example FXPro. Select the EUR/USD pair, and place a spread bet, going long with a specified stake.
FXPro offers you the option to use leverage, allowing you to control a larger position size with a smaller amount of capital. However, being aware of the risks, you decide to use a moderate level of leverage and set up a stop-loss order to limit potential losses.
The Euro performs as you predicted, strengthening against the US Dollar. The exchange rate moves in your favor, and the spread widens positively. As a result, your spread bet generates profits.
Forex Spread FAQs
Forex spread refers to the difference between the buying (ask) and selling (bid) prices of a currency pair, representing the cost of trading and the primary source of revenue for brokers in the foreign exchange market.
To calculate the spread in Forex, subtract the bid price (the price at which you can sell a currency pair) from the ask price (the price at which you can buy the same currency pair). The resulting value, often expressed in pips, represents the spread between the buying and selling prices.
Spread = Ask Price − Bid Price
The spread in forex is primarily determined by market liquidity, broker business models, and market conditions, with factors such as currency pair, broker technology, and economic events influencing the width of the spread.
Forex spread betting is a financial strategy where traders speculate on currency pair price movements, with profits or losses determined by the accuracy of their predictions relative to the spread between buying and selling prices.
It is not possible to completely avoid spreads in market environment, as they are inherent to the market and represent the cost of executing a trade. However, you can choose a broker that offers zero spread.
A high spread in forex means that there is a substantial difference between the buying and selling prices of a currency pair, which results with increased transaction costs and potential challenges for traders.
Low spread means that, there is a minimal difference between the bid and ask prices of a currency pair, suggesting lower transaction costs, increased liquidity, and potentially favorable conditions for traders.
A raw spread in forex refers to the direct and unaltered difference between the bid and ask prices of a currency pair, excluding any additional markups or commissions from the broker, providing traders with transparency regarding the true market pricing.
The spread in forex affects profit by serving as a transaction cost, requiring the market price to move beyond the spread width before traders can achieve a profit on their positions.