2023-09-29 15:52
What is Spread in Forex? (Spread Types & Factors Affecting It)
Spread is one of the concepts that traders in the financial markets must have accurate information about to make a transaction. In the financial markets, the difference between the buy price (Supply-ASK) and the sell price (Demand-BID) of a symbol or asset is called a Spread.
Further, we will answer the following questions.
What is a Spread in Forex?
Simply put, the spread is the difference between the buy price (Supply-ASK) and the selling price (Demand-BID). Spread is the cost of forex trading and is defined in pips. For example, if the bid price for the EUR/USD currency pair is 1.0000 and the asking price is 1.0005, the spread is 5 pips. The BID price is the price at which the trader can sell the base currency (EUR) and buy the quote currency (USD), while the ASK price is the price at which the trader can buy the base currency and sell the quote currency.
Spread Types in Brokers
There are two types of spread in Forex and brokers: Fixed and Floating spread. The point traders pay special attention to is the spread size in brokers, so for traders, the spread is one of the significant factors in choosing a broker. Trendo Broker has the lowest spread in symbols in line with the best services.
What is a Fixed Spread?
Some brokers in the financial market offer a type of account where the spread of symbols is fixed and precise at any time. Brokers offering fixed spread accounts are market makers. In these brokers, if the market undergoes significant changes and high volatility, only that spread will temporarily change to another fixed spread until the market returns to its normal state. It is called Requote. That means the broker here can cancel the trade, apply the new price and ask the trader to accept the new price. Usually, fixed spread accounts have more spread in symbols than floating.
What is a Floating Spread?
Most brokers have floating spread accounts. In these account types, the spread in currency pairs and other symbols changes and is not fixed. Also, the floating spread amount can differ in brokers depending on the account's type and balance.
In Trendo Broker, all accounts are of ECN, floating spread, and zero spread category type. That means the spread of most symbols has zero or the lowest value.
Factors Affecting Spread
As mentioned, in most brokers, the spread is not a fixed value and can vary depending on various factors. Some of the factors that affect the spread are:
1. Market Volatility: When the market is volatile, spread becomes larger as the risk increases. For example, at the time of the economic calendar's major news release, such as the interest rate or inflation meeting, the supply and demand balance is disturbed due to high fluctuations, and the spread increases as a result.
Read More: The economic calendar in Forex (how to use the economic calendar)
2. Liquidity: Currency pairs with a high trading volume tend to have lower spreads because of more buyers and sellers in the market. For example, major currency pairs (with the US dollar on one side) have a lower spread than others because of high liquidity and trading volume. Spreads of Euro to Dollar (EUR USD), Pound to Dollar (GBP USD), and Dollar to Yen (USD JPY) pairs are usually zero in Trendo.
3. Time of day: The spread can vary depending on the day's time. During the Asian trading session or the weekend's last and early forex moments, the spread tends to be wider because of less liquidity in the marke
4. Broker type: Different brokers have different spreads. TRENDO broker offers lower spreads as they connect traders directly to liquidity providers. Forex brokers earn from the spread by receiving a commission from traders in each trade. The commission is usually a small percentage of the spread and varies from broker to broker.
Why is Spread Important in Forex?
Spread is a significant factor to consider when trading Forex, as it affects the profitability of each trade. A higher spread means a trader has to make more profit to break even, while a lower spread means to break even, a trader has to make less profit. Traders can choose between two types of spreads: variable or fixed spreads. Fixed spreads do not change and are usually higher than variable spreads. On the other hand, depending on market conditions, variable spreads can change and usually are lower than fixed spreads. There are also various trading strategies that traders can use to minimize the spread's impact on their trades. One is to trade during times of high liquidity, such as when the New York and London sessions overlap, as spreads are narrower during these times. Another strategy is to use a broker that charges a lower spread since this can lower the overall cost of trading. Traders can also use stop-loss orders to limit losses if the spread unexpectedly widens.
Read More: What is a Trading Session? The right time for forex trading
How much is the Normal Spread Amount in Forex?
The spread can change depending on varied factors such as the traded currency pair, market volatility, and the broker you use. The spread can range from 0 pips to 10 pips or more depending on the currency pair and market conditions. In general, well-known major currency pairs such as EUR/USD, GBP/USD, and USD/JPY have much smaller spreads than lesser-known currency pairs such as USD/TRY or USD/BRL because major currency pairs are more actively traded and have higher liquidity, that means there is more competition between brokers to offer lower spreads. On the other hand, unknown currency pairs are less traded and have less liquidity, resulting in higher spreads. The number of traders in these markets is lower, which gives brokers more room to offer wider spreads.
In addition to the traded currency pair, market volatility also can affect the spread. During volatile times, spreads can significantly increase as brokers adjust their pricing to reflect increased risk in the market. This factor can lead to paying more to enter and exit trades. Finally, the broker you use can also affect the spread. Different brokers have different pricing standards that can affect the spread. Some brokers offer fixed spreads, meaning the spread remains fixed regardless of market conditions. Other brokers offer variable spreads, which means the spread can fluctuate depending on market conditions. However, as a general rule, a spread of 0-2 pips for major currency pairs and 2-5 pips for lesser-known currency pairs can be considered normal. But when the spread goes out of its normal state, it is called spread widening.
What is the Spread widening in Forex, and when does it happen?
As mentioned in the previous articles, some factors affect the amount of spread and may increase it from the normal state. It is called a widening when the currency pairs or other forex symbols' spread becomes several times the normal state.
Every forex trader should keep the spread widening times in mind. Because spread widening may cause unwanted losses. For example, let's assume that the spread of the New Zealand dollar to the Japanese yen symbol (NZDJPY) is usually 1 pip, but due to the lack of liquidity in the market's last minutes, the spread reaches 20 pips. Therefore, it is possible that due to the spread widening (An increase in the difference between the buy and sell prices), the trade's stop loss activates, and your transaction will be closed unintentionally, then this currency pair's spread will return to normal after a few minutes.
Now this question arises, when will the spread become wide? Further, we will discuss this issue, and traders should pay attention to the times when the spread may widen.
The start and end of the trading day: The forex market starts working with the Asian session and ends with the American session, usually at the beginning and end of daily trading, which is approximately from 21:00 to 22:00 UTC due to the bank transactions' settlement and the low liquidity volume, the spread is higher than usual. This point is more tangible in non-main currencies that do not have US dollars on one side.
Before and after weekend holidays: When we approach the last trading hours during the week on Friday, or the opening hours of weekly trading on Monday, due to the weekly trades' settlement and the low trading volume and liquidity, the spread is wide in most symbols.
The economic calendar's significant news release: at the time of the economic calendar's major news release, such as the interest rates or inflation meeting, the balance of supply and demand is disturbed due to high fluctuations, and as a result, the spread increases.
How does Spread affect Forex trading?
Spreads affect forex trading in several ways. First, it affects the transaction execution cost. The higher the spread, the higher the transaction cost. It means that traders have to pay more to enter and exit a trade, which reduces their profitability.
Additionally, higher spreads can make trading at the desired price more difficult, as fewer buyers or sellers may be willing to trade at that price. Secondly, the spread also affects the trade's profitability. When a trader enters a trade he must make a profit greater than the spread for it to be profitable. For example, if the spread is 5 pips and the trader wants to make a profit of 10 pips, he should earn 15 pips in total. It means that the spread dictates a significant portion of a trade's profit potential, and wider spreads can make it harder to achieve a profitable outcome.
Thirdly, the spread affects the selection of currency pairs to trade. Various currency pairs have different spreads, and traders may focus on pairs with lower spreads to reduce their trading costs. For example, the spread for EUR/USD is usually lower than for lesser-known currency pairs such as USD/ZAR or USD/TRY.
Traders may also trade during less volatile times when spreads are typically lower. Finally, the spread affects the overall liquidity of the forex market. A lower spread indicates a more liquid market, as more buyers and sellers are willing to trade at similar prices. It can make it easier for traders to place trades at the desired price and reduce the risk of slippage (the difference between a trade's expected price and the actual price at which it is executed).
Read More: What is Slippage? (Slippage in Forex)
Summary
Avoiding margin calls in Forex requires understanding margin requirements, maintaining adequate margins, using stop-loss orders, monitoring trades, and avoiding trading during news releases. It is important to remember that forex trading involves a certain level of risk, and managing this risk is essential to protect your capital. By following these tips, you can reduce the margin call risk and increase your chances of success in the forex market.