In forex trading, the “spread” refers to the difference between the bid price (the price at which you can sell a currency pair) and the ask price (the price at which you can buy a currency pair). It is essentially the cost of executing a trade in the forex market.
Bid Price
This is the price at which the market is willing to buy a currency pair from you. It is typically shown on the left side of a currency quote.
Ask Price
This is the price at which the market is willing to sell a currency pair to you. It is usually displayed on the right side of a currency quote.
Spread
The spread is the difference between the bid price and the ask price. It represents the broker’s profit margin and compensation for facilitating the trade.
If the EUR/USD currency pair is quoted as 1.25001/1.25003:
- 1.25001 is the bid price (the price at which you can sell euros).
- 1.25003 is the ask price (the price at which you can buy euros).
In this case, the spread would be 2 points (1.25003 – 1.25001 = 0.00002 or 2 points).
The spread can vary depending on several factors, including market liquidity, volatility, and the broker’s pricing model. It is a fundamental aspect of forex trading that traders need to consider because it affects the cost of entering and exiting trades. Lower spreads are generally preferred by traders as they reduce the overall transaction costs and improve profitability, especially for short-term trading strategies.
What types of Spreads are in Forex?
In forex trading, there are primarily two types of spreads that traders encounter:
Fixed Spreads
A fixed spread means that the difference between the bid and ask prices remains constant and does not change regardless of market conditions or volatility.
Brokers offering fixed spreads specify a certain number of pips (or fraction thereof) that will always be applied to each currency pair. For example, if a broker offers a fixed spread of 2 pips for EUR/USD, then the spread will always be 2 pips regardless of market conditions.
Fixed spreads provide certainty to traders because they know the exact cost of entering and exiting trades. This can be beneficial during times of high market volatility when variable spreads might widen significantly.
Variable Spreads (Floating Spreads)
A variable spread means that the difference between the bid and ask prices can change based on market conditions, such as liquidity, volatility, and economic events.
Brokers offering variable spreads typically quote spreads that fluctuate throughout the day. When market liquidity is high, spreads tend to be tighter (smaller), and when liquidity is low or during times of high volatility, spreads can widen (become larger).
Variable spreads can be lower than fixed spreads during normal market conditions, potentially reducing trading costs for traders, especially for frequent traders and scalpers who benefit from tighter spreads.
In addition to these two main types, some brokers also offer commission-based spreads:
Instead of widening the spread, these brokers charge a fixed or variable commission per trade in addition to a smaller spread. This model can sometimes result in lower overall trading costs, especially for traders who execute large volumes or have specific trading strategies that benefit from low spreads and separate commission charges.
Understanding the type of spread offered by your broker is crucial for managing trading costs and executing trades effectively, particularly in fast-moving markets where spreads can impact profitability significantly.
