What Is Spread In Forex Trading? How To Calculate Forex Spread (With Example)
Spread in forex trading is an article with various points so that traders can know the core value of trading with a spread. In forex, you will find two currency where one currency is the Base currency and another currency is the Quoted currency or Second currency.
Moreover, there are two different prices based on which you can trade the currency pairs.
- Ask Price
- Bid Price
Additionally, the forex market makers are willing to buy the base currency in exchange for the quoted currency. Similarly, they sell the base currency in exchange for the quoted currency.
In bid price, customer or market is willing to buy currency.
At the same time in ask or offer price, the currency sells at the possible lowest price.
Traders buy currency at the offer price and sell currency at the bid price.
Basically, in the Bid price, the trader enters into the market to sell currency pairs. In Ask price, the trader enters into the marketplace to buy currency pairs. In general, the Bid price is always lower than the Ask price.
The difference between a Bid price and Ask price is the spread.
In the beginning, we will discuss the definition of spread, types, and calculation. We will also show you the difference between two spread categories. In the middle of the article, you will get to know the factors that influences spread.
Spread Definition In Forex
The Spread is a broker’s profit margin. It also represents the broker’s service charges. However, the spread depends on the currency pairs as well as on the broker.
The most traded currency pairs have a higher amount of spread.
Instead of charging transaction charges, they offer spread to their traders. Negatively, brokers can affect traders by charging a higher spread.
It is also expressed as PIPS traditionally. We will give you a short example that helps you to understand the spread more precisely.
Suppose, you are trading EUR/USD currency pair. The currency pair price is $ 1.1670. The broker will offer you to buy at $1.1674 and sell at $1.1590. So, here the difference between the sell and buy price is Spread.
Types Of Spread
A Forex spread is the differences between the two prices.
In Forex trading, there are two types of spread available. These are:
- Fixed Spread
- Variable or Floating Spread.
Trading with fixed spread is less risky in the Forex marketplace. A fixed spread is profitable for news traders, day traders, and those traders who want to earn a profit within a short time.
The fixed spread is always higher than the variable spread. Because in the fixed spread, brokers include insurance cost.
It is basically a spread that does not change depending on the time, broker’s rules, general market price fluctuation, and volatility.
However, the fixed spread sometimes changes depending on the market condition.
After changing, it becomes a new fixed Spread in the trading market.
Without a doubt, a fixed spread is more predictable than the variable spread.
In the fixed spread, the spread always remains the same. It will help traders to identify the cost before opening a position.
A variable spread change depends on the market volatility as well as the correlation of the market condition.
This type of spread continuously change depends on the bid and ask price.
The floating spread is low when the market is inactive. During the market volatility, the spread is widening up with much higher PIPs. It increases up to 40-50 pips when the market is active.
Floating Spread is closer to the real market. But, while trading in the forex marketplace, it brings a higher level of uncertainty.
Market condition changes when the news announcement comes out. Brokers face trouble to trade that time with a high spread.
So far, forex spread is the profit margin for Brokers who do not take extra charges from their trades.
However, trading in the ECN platform has a very low amount of spread. At the same time, traders need to pay commission to their Brokers.
How To Calculate Bid-Ask Spread In Forex
Being a trader, you need a trading account with a broker to communicate with the forex market.
To calculate the profit margin, traders need to have an idea on spread calculation.
You will get the spread value after subtracting the Bid price from the Ask price. The Spread is usually a percentage.
Spread Calculation Example:
The formula of calculating spread (Mannually) – Spread = Ask Price – Bid Price.
For example, you are ready to trade EUR/USD at the bid-ask price of 1.1249/1.1250. You will buy the currency pair at the Ask price of $1.1250. Similarly, you will sell it at the Bid price of $1.1249. So, the difference represents a spread of 1 pip.
On the other hand, there is also another price level, which is known as the Mid-price.
The Mid price is not often used in the currency marketplace. You simply add Sell, Buy price together, and divide by 2.
In general, traders get mid-price when the market is very slow and volatile.
Let’s see an example of mid-price:
Suppose you are trading the currency pair NZD/CHF. The selling price is $1.2656 and the buying price is $1.2670.
The calculation of Mid Price is = ($1.2656+$1.2670)/2 = $1.2663
So, the Mid-price is $1.2663.
Calculating the value of spread, you also need to have an idea on pip value.
Pip is the price-changing indicator in the Forex market. You can measure the currency movement with the help of pip value.
The number of Pips also expresses the spread. Pip cost is exponential.
That means traders will need to multiply pip value based on the number of lots you are trading.
So, to calculate spread, move the decimal point 4th place of the right of your current asset price and then deduct the Bid price from the Offer price.
For Japanese Yen, you have to move the decimal point 2 places of the right of your trading currency pair to calculate spread.
What Is Zero Spread
Most of the case, traders are new and do not know much about trade business. Spread cost is a combination of a broker’s commission, the broker’s tax, software charges, etc.
Zero spread means no brokers cost. Traders trade assets without paying commission.
While brokers offer zero spread, that means they will make money in other ways. Therefore, it is impossible to open a position in Forex without the spread.
So, the zero spread means you can perform trade with a spread, that is as low as zero.
Which One Is Good For Trade? - Fixed Spread Or Floating Spread
The differences between the fixed spread and the variable spread are minimal.
When you select a broker, you will see a couple of different spreads available depending on the account types.
Most of the analyst or brokers suggests fixed spread to their traders.
The logic behind their suggestion is the transparency of the trading market. Some traders think that the variable spread suits them because they can adjust to the market as well as with the trading risk appetite.
But, selecting the right spread type totally depends on the strategy of one’s trading. To open a position, you have to concentrate properly on different news sites.
There are a few differences between these two spreads. The fixed spread is always fixed no matter how the market condition is.
On the other hand, variable spread changes depending on various factors.
The differences between these spreads are not that much alarming for traders. Those who traded long-term trading will place less trade.
Therefore, they don’t bother that much. But, it is alarming for short-term traders. They want to get small pips from their trading.
Scalpers get benefits from the fixed spread. In the fixed spread, it is easy to know the profit or the break-even which is not possible in floating spread.
When the market gets volatile, the spread widens up. So, the variable spread is not for day traders and scalpers.
The fixed spread is also providing a predictable trading environment so that, most of the new traders and upcoming traders prefer fixed spread during their trading.
The variable spread is much lower than the fixed spread. It is the negative side of the fixed spread. This happens when the market is in high liquidity. However, variable spread rises very quickly during the volatile market.
Most of the time, scalpers are also preferred variable spread. When the market is in high liquidity then it is easy to get high profit. It is the reason why these types of traders prefer floating spread during this market condition.
What’s important is that not all traders will experience the same benefits.
In the end, it comes down to personal choice whether to use the fixed spread or the variable one.
Here, we are going to discuss some factors which are affected by the spread price.
What Influences The Spread In Forex Trading
Spread changes depending on some factors. Increasing and decreasing the price of Bid and Ask depends on those factors.
One of the major influences is currency liquidity. Traders trade popular currency pairs on a regular basis.
Popular pairs have the tightest spread. Major currency pairs have the highest active number of market makers.
Secondly, the lot size. If you trade with a midsize, then the spread remains very tight.
You will find widen up spread while dealing with the too big size or too small size of the amount. It happens because risk factors are involved there.
Bid price and Ask price is changing continuously depends on market volatility. The market prepares for widening up spread in volatile condition.
On the other hand, some traders enjoy their trading environment while the market is too active.
Nowadays, brokers are trying to stay close to their traders. So, now spread is tend to be fixed at the lowest possible level.
When the news events or any type of announcement comes out, the market condition gets volatile. Forex spread got widen up that time. The political election is also playing a vital role in market volatility.
Each trader should pay sufficient attention in spread while they are traded the currency pairs in the marketplace. Trader’s performance depends on their trading tricks and the profit depends on the spread count.
The successful trading strategy is based on effective market evolution and also on market indicators.
Which Is Better - Commission Or Spread
Similar to the spread, the commission is also a broker’s profit margin. Before opening a trade, you have to pay commissions to your broker.
Remember that the broker will deduct the amount from your capital, not from the balance. The amount is fixed for traders.
Somewhat, a few brokers especially, ECN, STD accept commission on trader’s profit. On the other hand, some brokers offer zero spread account. In a zero spread account, the commission is based on the trade volume.
Traders have to pay a bigger commission if they trade a bigger amount. This types of fees are allowed when the market is full of low liquidity, or any news comes up through media.
For traders, it is better to pay a commission than the wider spread.
Even though, some brokers offer tight spread with no commission. Especially, market maker applies this trick.
They do not accept some trading strategies like scalping. A high commission charge is based on the broker’s services like advice.
We are almost at the bottom line of our article. Now, we will give a short brief on managing and minimizing the spread actively. Before that let’s have an idea on spread betting.
What Is Spread Betting In Forex
Spread betting in Forex happens when a trader bet on the price movement of currency pairs. As we all know, there are two prices available in the currency market, one is the Bid price, and another one is the Ask price.
Traders bet whether the price of the currency pair goes up or down compared to the Bid price or the Ask price.
Traders do not need to own any particular currency pairs to do Spread Betting. Your account simply needs to fulfill with that currency where the betting service is located.
The profits will be tax-free. However, you have to follow some rules and strategies to take your trading to the next level.
Traders do not need to pay commissions after performing spread betting.
How To Manage And Minimize Spread Cost
The following factors will help traders to manage and minimize the spread cost.
It is better to trade during the most favorable trading hours. Based on the real-time, traders perform trading 24 hours.
The favorable time means when the number of traders is the highest amount. In that time, the spread cost is limited.
Multiple market makers compete for business when traders trade popular currencies, such as the GBP/USD pair.
If you trade a thinly traded currency pair, there may be only a few market makers to accept the trade. And after reflecting the lessened competition, they will maintain a wider spread.
Spreads hit your trade when you will open and close your trade position. It is better not to open and close your trade during the news event. After a while price will go back to the normal point and you can enjoy your trade.
At the bottom line, it is necessary to keep on your mind that spread is really an important term for traders.
Apart from the fixed spread, the variable spread will change very rapidly depending on the trading market condition.
However, fixed spread id very popular on novice traders. On the other hand, we have mentioned various factors that are responsible for changes in spread.
Remember, your trading cost will change based on your spread and on your lot size.