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Understand how forex spread work and what is it

Updated: 3 March 2020 | 05:08 PM

Understanding the Forex Spread

One of the important topic is ‘Forex Spread’ is forex traders. See how forex spread work and how affects you.

forex spread

What is Spread in Forex Trading?

Forex spread is a quote between the two different currency pairs, it is the bid and ask price.

The bid price: is a sale base currency in which you can buy the price. 

The ask price: is a buy base currency in which you can buy the price.

So, the difference between the bid price and ask price is known spread.

See an example in Bellow we being calculated for the EUR/USD. The spread is actually measured pips, most currency pairs, one pip is equal to 0.0001. Forex pips is calculated as the smallest unit of the price movement of a forex currency pair.

So like a quote of the EUR/USD currency pair is, bid = 1.5709 and ask = 1.5712. Then the quote tells the spread of 3 pips.

But, in the Currency pair Japanese yen quoted to only 2 decimal places without there are fractional pips, then its 3 decimals.

Such as EUR/JPY would be 150.00/154.04. Then the spread is 4 pips.

Types of Spreads in Forex

Actually the spread type depends on the broker and how the forex broker makes money. The type of spread you can see on the broker trading platform.

Usually, there are two types of spreads:

One is Fixed spread and another one is Variable spread, the Variable spread is also known as floating spread.

What is Fixed Spread in Forex?

Forex brokers who operate as dealing desk model or work as a market maker, they offer Fixed spreads.

It depends on market conditions at any given time. A market maker or dealing desk broker buy large positions and offers smaller sizes. They buy large positions from the liquidity providers and offer smaller sizes to their clients/traders.

Dealing desk broker offers fixed spreads, they can control the prices they display to their clients.

Advantages of Trading With Fixed Spreads

Trading with fixed spreads is very interesting for some traders because fixed spreads have smaller capital requirements.

So who is a beginner or don’t have a lot of money, he/she can start forex trading with the fixed spread. Actually it’s an accessible choice for traders.

And the best thing is that it makes more predictable transaction costs.

Disadvantages of Trading With Fixed Spreads

The bad thing about the fixed spreads is the price comes from only the broker, which means it’s a single source.

Forex market is unpredictable, their prices are rapidly changing and the market is volatile also. Since the spreads are fixed and the forex broker cannot broaden to make it sweet for the current market conditions or requirements.

Another problem is the slippage. When the market moves fast the broker cannot control the fixed spreads. When you will complete a trade the price will be different from the starting trade price.

So sometimes experts say it’s similar to the negative attraction but different.

What are Variable Spreads in Forex?

As the name, you can guess the variable spreads mean continuous changing spreads.  The variable spreads are the difference of constantly price changing between the bid price and the ask price.

All brokers who work as non-dealing desk model, they offer the Variable spreads and have no control over it. This why spreads will broaden or tighten depends on the market volatility and supply and demand of currencies.

Advantages of Trading With Variable Spreads

The variable spreads give a good experience for the different market conditions.

Also, if you are looking for a transparent price, the variable spread is the best choice. Due to market competition, the best price comes from multiple liquidity providers.

Disadvantages of Trading With Variable Spreads

Scalpers don’t love variable spreads. The fixed spreads are ideal for them. Due to the behavior of variable spreads, the winded spreads can quickly eat into whole profits.

And, it’s not good for news traders. News traders always avoid variable spreads because it has broadened spreads.

A lot of profit turns into loss within a blink of an eye.

Fixed vs Variable Spreads

If you are thinking about which spread is the better, the answer depends on you.

Actually spreads are depend on the traders. Already you know that which types or categories traders love which spreads.

It’s similar to Milk! How?

We knew milk is an ideal food but everybody don’t love food. Which food human do love, it depends on the human character.

The spreads are also similar to the trader character, which things they are trading.

Due to the market conditions and characteristics of trading instruments, fund amount and generating profit traders love both fixed and variable spreads.

So, there are many traders who find, choose and love fixed spreads and many traders also love variable spreads.

Usually, traders who trade with smaller funds and trade less frequently trade with the fixed variables.

And traders with larger funds and trade frequently they love variable spreads.

Also, due to trade execution time, sometimes traders are avoid fixed spreads because it cannot provide fast trade execution.

How to calculate the spread cost?

Now, already you know that what is the spreads (the difference between the ask price and bid price) and the types of it.

The calculation of the spread cost is pretty easy. Look bellow how the cost does calculate:

We can calculate spread in two different ways:

Pip value: the actual value per pip and

Lots number: the number of lots you/trader are trading

Sea the quote of EUR and USD.

EUR_USD quote

In this quote, you can buy EURUSD at 1.23720 and sell EURUSD at 1.23706.

So, if you buy it will close within a few secs and then the result will be 1.4 pips loss.

So the cost will come after multiplying the cost per pip by lots you’re trading.

Here, if you trading 10,000 units (mini lots), the value is $1 the cost would be $1.40.

Lots number Way

way to spread calculation

In the image the pip cost is linear. Here we have to calculate the cost through the number of lots of trading.

Like if the spread is 1.2 pips and you trading 5 mini lots, then transection cost would be $6.

 

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