Spread in Forex and How it’s Calculated
One of the most important topics to deal with in forex is spread. No wonder it’s a pillar in the trading process as its volume has a great impact on the profits or losses of your trade.
Just like the leverage, you need to know how to calculate the spread in forex and what types of spreads to carry on with a successful trade.
How to calculate spread in Forex? and what is Forex Spread meaning? are good questions to start finding some answers to.
With all the complex sentences and complicated Forex Spread definitions everywhere, let’s make it as simple as possible to make a bit more sense. Forex Spread meaning is that it’s the difference between the buy ( which is also called ask) and the sell ( which is also called bid) price while trading.
and to make things clearer, let’s explain exactly what’s the bid and ask price in forex.
The ask: the price rate where the trader agrees to buy the currency pair.
The bid: the price rate where the trader agrees to sell a currency.
Note that the selling price is normally higher than the buy price.
Now that we know the spread in forex meaning and what it’s defined as it’s fair to mention that spreads have 2 types within the forex market and these Forex spread types are:
Fixed spreads are more used in automatically traded accounts. And its when the difference between the buy and sell price is unchangeable and is fixed on a specific amount or rate.
Also called the floating spread or dynamic spread. This type of spread is where the spread rate fluctuates with the market fluctuation. And so that means spreads and market stability is directly proportional to each other. If the market is stable the spreads are low, and if the market is volatile or has a fast-changing pace, alternatively the spreads would be higher.
Spreads are applied to cover the costs of finding traders and to cover the fluctuation of prices, and here’s how.
Think of the spread as a commission, paid for by the middle man (the third party) who’s responsible for finding the buyers and sellers within the trading process. As the middle man would also carry the responsibility of ensuring a smooth flow of the trade.
Also, assume that the middle man or the third party 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 a certain amount of money to counter this risk.
And so, spreads exist to cover those costs.
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 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.
For more detailed information, you can read Pips.
How to Calculate Spread Costs?
The total cost of the spread can be calculated by this equation:
Costs = Spread x Pip Cost x Number of lots
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.
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. So lower pips and tight spreads.
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.
We have covered all the points that can be confusing or questionable about the spread meaning in forex, here are some questions that frequently asked about the topic.
How to Calculate Spread in Forex?
It’s the subtraction of the buy and sell price and the result of the equation is the spread amount. The spread is measured by a unit called the pip.
What is Forex Spread meaning?
The Forex Spread Definition is that it’s the difference between the ask and the bid price for a currency within the currency pairs while trading in forex. 2 types of spreads are frequently used within the forex broker houses, fixed and variable spreads.