When making a trade through the forex markets you will be required to go through a middleman such as a broker.
A broker will charge you a fee for using their services, this fee is the “forex spread”.
The spread is essentially the difference between the bid price and the asking price for a trade.
This is how brokers will make a profit instead of charging a transaction fee.
How Is The Forex Spread Calculated?
When placing an order you will be given a quote with a bid and ask price.
The bid price being the price that the forex market maker is willing to buy the base currency.
The ask price being the price that the forex market maker is willing to sell the base currency.
It is the difference between the bid and ask price which is called the spread.
If EUR/USD has a bid price of 1.16636 and an ask price of 1.16646 the the spread would be 0.00010.
Types Of Forex Spreads
There are different types of spreads used in the forex market such as fixed spread or variable spread.
Fixed Forex Spread
A fixed spread is the where the difference between ASK and BID is kept constant.
The spread does not depend on market conditions and the broker guarantees that the spread will always remain the same.
Variable Forex Spread
Variable spreads can fluctuates in correlation with market conditions.
A variable spread will generally be lower during times of market inactivity but during market volatility it can increase.
Although closer to real market, a variable spread can bring higher uncertainty to a trade.
Why Is The Spread Important?
For each currency pair the size of spread will be different.
There are a few factors that can influence the size of the bid-offer spread.
The most important is currency liquidity.
- Currency pair liquidity – The most liquid currency pairs such as major pairs tend to have the tightest spreads.
- High volume trading – Higher volumes indicates many active traders leading to tighter spreads.
- Volatility – During times of volatility spreads are wider compared to quiet market conditions.
- Trader status – large scale traders or premium clients can sometimes receive better spreads.
When trading a it can be wise for a trader to pay attention to spread management.
As spreads are subject to change, it is the changes in the spread that can affect your overall profits.
For a trader that trades with lowest possible spreads he will then have less operating cost and increase his profits.