Shoresh Ghaderi

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2023-07-20 17:32

What is Spread in Forex Trading?

Spread in forex and financial markets is the difference between selling and buying prices. Stay tuned for more details about this concept in this article.
What is Spread in Forex Trading? What is Spread in Forex Trading?

In financial markets, the term ‘spread’ refers to the gap between the demand price, also known as the ‘BID’, and the supply price, or the ‘ASK’. Learning this concept is crucial for anyone involved in forex trading, as it plays a significant role in risk management.

So, stick around as we delve deeper into the concept of spread in the forex market and explore its various types.

Contents

What is a spread in the forex market?
Types of spreads in brokers
Factors affecting the spread
What is a widening spread in Forex, and when does it occur?

What is a spread in the forex market?

In the world of financial markets, ‘spread’ is defined as the discrepancy between the ‘BID’ (demand price) and the ‘ASK’ (supply price).

Essentially, the spread represents the cost of executing a trade in the forex market, and it’s quantified in units known as ‘pips’. To illustrate, if the BID price for the EURUSD pair stands at 1.000000 and the ask price is 1.0005, then the spread amounts to 5 pips.

The ‘BID’ price is the rate at which a trader can sell the base currency (in this case, EUR) and purchase the counter currency (here, USD). Conversely, the ‘ASK’ price is the rate at which a trader can acquire the base currency and offload the counter currency.

If your intention is to buy a symbol in the market, you’ll need to refer to the ‘ASK’ price, and if you’re looking to sell, you’ll use the ‘BID’ price.

What is a spread in the forex market What is a spread in the forex market

Types of spreads in brokers

The spread in the forex market is a crucial factor for trading, as it has a significant influence on the long-term profitability or loss of a trading account.

Essentially, a higher spread can lead to lower profits. Forex market brokers typically offer spreads in two forms: fixed and floating. Understanding these types can help traders make informed decisions and potentially increase their profitability.

Fixed spread in Forex

Some brokers provide trading accounts that feature fixed spreads. In such accounts, the spread is set at a specific value and remains constant. These brokers, often referred to as ‘market makers’, typically offer accounts with fixed spreads.

However, it’s worth noting that these fixed spreads are usually set at a relatively high value. Moreover, during critical market periods, these brokers may increase the spread further, maintaining it at an even higher constant value. This practice is something traders should be aware of when considering fixed spread accounts.

Advantages and disadvantages of fixed spreads

The only advantage of a fixed spread is that it does not change, and for strategies that are done with AIs and automatically, the cost parameter of the spread can be considered fixed, and simpler calculations can be made.

However, the downside of a fixed spread is that it tends to be significantly higher compared to its counterpart, implying that your trading costs could escalate. This is an important consideration for traders when evaluating the cost-effectiveness of their trading strategies.

Floating spread (Variable) in Forex

Most brokers typically offer accounts with a floating spread, where the spread fluctuates over a short period. Despite this variability, these accounts generally feature a lower spread compared to those with fixed spreads. For instance, all accounts offered by Trendo Broker are of the ECN type and operate on a floating spread basis.

Trendo International Broker strives to provide the best trading conditions by offering the lowest spreads for trading. You’re encouraged to compare the spreads offered by Trendo Broker with those of other brokers to ensure you’re getting the most favorable conditions for your trading activities.

You can use Trendo's trading platform or the following link to see Trendo's spreads on the days when the market is open:

Advantages and disadvantages of floating spreads

The primary benefit of floating spreads is their typically lower value, resulting in smaller transaction fees for you. This can make a significant difference to your trading costs over time.

However, it’s important to note that floating spreads come with their own set of challenges. During certain periods, such as the release of significant economic news, floating spreads can widen considerably. This fluctuation can impact your trading calculations, particularly when it comes to determining your take profit and stop loss levels.

Therefore, while floating spreads can offer cost advantages, they also require careful monitoring and management during volatile market conditions.

How to calculate spread in forex

To calculate the spread in brokers, calculating the difference between the BID and the ASK price in the desired symbol is enough. It’s worth noting that with Trendo Broker, there’s no need for manual calculations of the spread. The spread for each symbol is conveniently displayed in the ‘Watchlist’ section, making it easy for you to monitor and manage your trades.

Factors affecting the spread

The spread is not a fixed value and depends on various factors, the most important of which are:

Market volatility: When market volatility increases significantly and the trading risk increases, the spreads also increase. For instance, during the release of crucial economic calendar news such as GDP index announcements or inflation data, you may observe a slight increase in the spread.

Read more: The economic calendar in Forex (how to use the economic calendar)

Liquidity: Generally, a trading symbol with a higher trading volume and liquidity will have a lower spread. For instance, in Trendo Broker, the spread for highly liquid symbols like EURUSD and USDJPY is zero, indicating no difference between the ‘Bid’ and ‘Ask’ prices. On the other hand, symbols with lower liquidity, such as CHFPLN, tend to have higher spreads. Understanding the relationship between liquidity and spread can help traders choose the most suitable symbols for their trading strategies.

Trading session: The liquidity of the market, which is significantly influenced by the trading session, directly affects the spread. During high-liquidity sessions, such as the London or New York trading sessions, spreads tend to be lower due to the high volume of trades. Conversely, in trading sessions characterized by lower liquidity, such as the Oceania or Asian sessions, spreads are likely to increase.

Broker type: The type of broker plays a significant role in determining the spread. Each broker’s spread varies depending on their respective liquidity provider. For instance, Trendo Broker, by directly connecting traders to liquidity providers, is able to offer very low trading spreads.

Forex brokers generate revenue by charging a commission or fee on each transaction made by traders. This commission is typically calculated based on the trading volume. In this context, Trendo Broker stands out by offering the best trading conditions with the lowest fees. For more detailed information, you can reach out to Trendo Broker’s support team. They would be more than happy to assist you with any queries you might have.

You can see the most important currency pairs' spread and trading symbols in Trendo Broker in the image below:

Factors affecting the spread Factors affecting the spread

Spread fee calculation

Most brokers display the amount of spread in pips. To calculate the cost of the spread, you would first convert the spread amount into pips. Then, multiply this value by the pip value of the desired symbol and your trading volume. The resulting number represents the cost of your spread.

For more information, refer to the article what is a pip in Forex?

Why is spread important in Forex?

The spread is a vital aspect in Forex trading as it directly impacts the profitability of your trading account. A high spread means you must make more profit to break even on a trade.

Read more: Introduction and review of trading sessions and the right time for trading in Forex

How much is the normal spread in the forex market?

Indeed, the spread in Forex trading is influenced by several factors, including the type of currency pair, market volatility, and the broker’s characteristics. Its value can range anywhere from zero to 10 pips.

Typically, major and well-known currency pairs like EURUSD, GBPUSD, and USDJPY have lower spreads compared to less popular pairs such as USDTRY or USDBRL. This is primarily due to their higher liquidity.

Market volatility is another key factor that can affect the spread. For instance, during the announcement of significant economic news, spreads can widen considerably.

However, as a general guideline, a spread of 0-2 pips for major currency pairs and 2-5 pips for other currency pairs is usually considered normal. It’s important for traders to be aware of these factors when planning their trading strategies to ensure optimal profitability.

How does the spread affect Forex trading?

The combined sum of the spread and commission is essentially the fee you pay to your broker for executing a trade. If you’re a day trader or a scalper, it’s generally more beneficial to work with a broker that offers low spreads and commissions. This is because high spreads and commissions can negatively impact your trading performance over time.

While the spread might not seem significant for a single trade, it can have a substantial impact on your trading account in the long run. This is due to the cumulative effect of the spread cost on each trade you make.

Trendo Broker, known for its low spreads, can be a good choice for your trading activities. By choosing a broker with low spreads like Trendo, you can potentially enhance your trading performance and profitability over time.

What is a widening spread in Forex, and when does it occur?

In Forex trading, a ‘widening spread’ refers to a situation where the spread of a trading symbol increases significantly beyond its usual range. This can occur due to various factors and can have a substantial impact on your trading activities. As a trader, it’s important to be aware of the potential for spread widening and adjust your risk management strategies accordingly.

A spread typically widens in the following scenarios:

Beginning and End of Trading Days: The start and close of the trading day often see increased market activity, which can lead to a widening of the spread.

Beginning and End of Trading Weeks: Similar to daily trading, the opening and closing of the trading week can also result in increased market volatility and a wider spread.

During Important Economic News Releases: Significant economic news releases can cause sudden market volatility, leading to a widening of the spread.

It’s crucial for traders to monitor these conditions and adjust their trading strategies to manage the potential risks effectively.

Read more: What is Slippage?

Summary

Avoiding margin calls in the forex market requires a combination of understanding margin requirements, using stop loss, and proper trade monitoring, and this requires that you properly understand basic and applied concepts such as lots, spreads, and pips.

In this article, we’ve delved into the concept of spread and its types in the forex market. We’ve also highlighted instances when the spread may widen significantly. By understanding these aspects, traders can better navigate the forex market and potentially enhance their trading performance.

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