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 mainly counted as a broker’s profit margin. Also, it represents the broker’s service charges. As the spread is a transactional cost, so it depends on different factors.
However, market makers have a great influence on the spread. Instead of charging fixed transaction fees, they offer spread to their traders.
On the other hand, major currency pairs hold a higher amount of spread.
Traditionally, it is also expressed as PIPS. Now, we will give you a short example which 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
As we mentioned before, 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.
So, traders can choose either both spread types or can select one depending on the trading account type.
- Fixed Spread
Trading with fixed spread is less risky in the Forex marketplace. A fixed spread is profitable, especially for news traders, day traders, and those who want to earn short-time profits.
Moreover, the fixed spread is always higher than the variable spread because of the insurance cost. Fortunately, it does not change depending on the time, rules, price fluctuation, and volatility.
However, in some cases, it 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 and mostly remains the same. Also, it will help traders to identify the cost before opening a position.
- Variable Or Floating Spread
A variable spread change depends on the market volatility as well as the correlation of the market condition. However, the spread type continuously change depends on the bid and ask price.
Notably, the floating spread is low when the market is inactive. During the market volatility, the spread is widening up with much higher pips. Also, it increases up to 40-50 pips when the market is active.
On the other hand, the floating spread is closer to the real market. But, it brings a higher level of uncertainty in the currency market.
Mostly, the market condition changes when the news announcement comes out. Brokers face trouble to trade during that time with a high spread.
Moreover, you can trade with a very low spread through the ECN platform. But, at the same time, traders need to pay commission to their Brokers.
How To Calculate Bid-Ask Spread In Forex
To calculate the profit margin, traders need to have an idea on spread calculation. Generally, you will get the spread value after subtracting the Bid price from the Ask price. The outcome will be in 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 that is known as the Mid-price. The Mid price is not often used in the currency marketplace. However, traders get midprice when the market is inactive and less volatile. You simply add Sell and Buy price together and divide by 2.
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 outcome is $1.2663.
Moreover, to calculate the spread value, a trader also has an idea on pip value. Pip is the price-changing indicator in the Forex market that cost exponential. The exponential cost indicates that traders need to multiply the pip value based on the number of trading lots.
You can also measure the currency movement with the help of pip value. Notably, the number of Pips also expresses the spread.
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. Similarly, for Japanese Yen, you have to move the decimal point 2 places of the right of your trading currency pair to calculate spread.
Get an online spread calculator to calculate spread, without any manual effort.
What Is Zero Spread
Most of the case, traders are new and do not know much about the trading business. So, they often get confused on whether to pick a broker that offers zero spread or not.
Spread cost mainly a combination of a broker’s commission, tax, software charges, etc. In a few cases, broker’s allow traders to trade with spread instead of charging a commission.
But, in zero spread, traders are allowed to trade with as low as 0 pip or none. Instead of spread, traders usually pay a fixed commission.
However, while brokers offer zero spread, that means they will make money in other ways. So, it is wise to evaluate the broker’s platform before opening a real account. Most importantly, zero spread account is potential for day traders, scalpers as well as those who place high-volume of trades.
Trading with zero spread has some advantages, along with disadvantages. The major advantage is that you can access directly to the forex market.
Which One Is Good For Trade? - Fixed Spread Or Floating Spread
The differences between fixed and variable spreads are minimal. In the broker platform, you will find different types of spreads available, depending on the account types. Selecting the right spread type depends on the trading strategy.
To open a position, you have to concentrate properly on different news sites. There are a few differences between these two spreads though, the differences are not that much alarming for traders.
# Trader Type
The fixed spread is always fixed no matter what the market condition is. But, variable spread changes depending on various factors. Long-term traders usually place less amount of trades.
But, choosing the wrong spread type can be alarming for short-term traders. Scalpers get benefits from the fixed spread. At the same time, it is easy to know the profit or the break-even, which is not possible in floating spread.
On the flip side, the variable spread mainly widens up when they get a volatile market. So, this spread type is not for day traders and scalpers.
# Spread Percentage
The fixed spread also provides a predictable trading environment. So, most of the new and upcoming traders prefer fixed spread.
Moreover, the variable spread is much lower than the fixed spread. It 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. At that time, it is easy to get high profit.
Most importantly, not all traders will experience the same benefits. In the end, it comes down to personal choice either to use the fixed spread or the variable one. In our next phase, we will discuss some factors that influence spread.
What Influences The Spread In Forex Trading
Several factors influence spread in forex trading. Mainly, these factors determine either the spread will increase or change in forex trading.
In the beginning, we will mention the list of main things that effect spread:
- Active hours
- Trading volume
- News events
One of the major influencers is liquidity. Market liquidity refers to how many traders are actively buying and selling currency pairs. Generally, higher liquidity brings the smallest spread. So, the major currency pairs have a smaller spread compared to minor and exotic pairs.
On the other hands, the bid and ask price changes continuously depend on market volatility. Usually, the market prepares for widening up spread in volatile condition.
When the news events or any type of announcement comes out, the market condition gets volatile, and forex spread gets widen up that time. The political election is also playing a vital role in market volatility.
Each trader should pay sufficient attention to spread while they trade the currency pairs in the marketplace. To minimize spread, you can choose active hours when the market is volatile. Trader’s performance depends on their trading tricks, and the profit depends on the spread count.
In the end, you can build a successful trading strategy based on effective market evolution and 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 a fixed amount from your capital, not from the balance.
Rarely, a few brokers especially, ECN, STD accept commission on trader’s profit. On the other hand, some brokers offer zero spread account where the commission depends on the trade volume.
Traders have to pay the high rate of commission if they trade a bigger amount. Brokers only allow the types of fees when the market is full of low liquidity.
For traders, it is better to pay commission instead of the widened spread, though, some brokers offer tight spread with no commission. Especially, market maker applies this trick. They do not accept some trading strategies like scalping.
What Is Spread Betting In Forex
Spread betting in Forex happens when a trader bets on the currency price movement. 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 either the price of the currency pair goes up or down compared to the bid and ask price. Also, you do not need to own any particular currency pair to do Spread Betting. Your account simply needs to fulfil 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. Moreover, 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 favourable trading hours. Based on the real-time, forex trading allows you to trade 24 hours.
The favourable time means when the number of active traders is the highest amount. Because, at 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 who accept the trade. Also, 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, a fixed spread is very popular among novice traders. On the other hand, we have mentioned various factors that are responsible for changes in spread. So, you can choose the spread type depends on your trading type.
Remember, your trading cost will change based on your spread and lot size.