In Forex trading, all operations with currencies take place with the participation of an intermediary, that is, an online broker. It provides the desired transaction, but it is not a free service. Each transaction is carried out with fees, which are included in the cost of each one. Thus, the profit of an online broker is the difference between the asking price and the bid price. It is the basis of what does spread mean in Forex.
What is spread in Forex trading?
So, Forex spread meaning is the difference between the price at which buyers are willing to buy a currency pair (bid price) and the price at which sellers are willing to sell it (ask price). FX spread is defined in points — the smallest unit of measurement in Forex trading.
When you enter a trade, you must pay the spread, which means the market price must change in your favor by at least the amount of the spread for you to make a profit. For example, if the EUR/USD spread is 2 pips, and you go long (buy) at 1.2000, the market price must rise to at least 1.2002 before you break even.
The spread may vary depending on the currency pair being traded, market conditions, and the broker you use. Generally, major currency pairs have narrow spreads, while exotic currency pairs have wider spreads. When trading, it is essential to keep the spread in mind as it can affect your profitability and overall trading strategy.
It is principal to understand that spread can be of two types:
When trading currency pairs, a trader typically deals with variable spreads, because it is thanks to this that it is possible to get profits from the transactions made. However, while traders expect the spread to change due to news, events, and other factors, this also means volatility. You have to look for the narrowest spread option and avoid requoting.
With fixed spreads, the transaction price remains stable, regardless of the influence of factors. This is always a predictable situation. However, in this case, many profit opportunities disappear. In the meantime, it is easier to find those brokers on Forex that offer low spreads and save due to it.
Also read: Get The Best Forex Rates With Crypto
What determines the spread in Forex?
Forex trading spreads are most impacted by market volatility. Generally, the spread tends to widen as a result of major geopolitical events, as well as news releases, fresh economic data, etc. As a result, market uncertainty increases, spreads widen as traders become more cautious and brokers try to hedge against potential losses. In addition, other factors impact the spread.
- Liquid currency pairs usually have tighter spreads because there are more buyers and sellers in the market, which increases competition and narrows the spread. On the other hand, exotic currency pairs are less liquid and, therefore, have larger spreads.
- Spreads are different for different brokers. Some of them offer quite favorable terms or fixed spreads.
- The spread may widen when there is high trading volume, as liquidity providers may need to hedge against the risk of large orders.
- During active trading hours, when there are more traders in the market, the spread is often smaller. However, during off-hours, when trading activity is lower, the spread may widen.
So, the spread primarily depends on the balance of supply and demand for a particular currency pair at any given time. Based on the spread Forex definition, the spread directly affects the cost of trading operations and the trader’s profits. That is why it is so important to understand how it is formed, as well as how to calculate it correctly. Even when you trade with the help of a robot, it is essential to know about these things in order not to face unnecessary risks. By the way, you can learn more about how to use trading robots and what they are here: https://forexstore.com/best-forex-robots
How to calculate spread in Forex
To calculate Forex trading spreads, you need to know the bid and ask prices of the currency pair you are trading. For example, consider the EUR/USD currency pair, where the bid price is 1.2000 and the asking price is 1.2003.
Subtract the bid price from the bid price to get the spread.
1.2003 (ask price) – 1.2000 (bid price) = 0.0003 or 3 pips
Therefore, the spread for EUR/USD is 3 pips.
To convert the spread into the base currency of your trading account, you must multiply the spread by the value of the item.
For example, if the spot price for EUR/USD is $10 per standard lot (100,000 units), the spread value for a standard lot trade would be:
3 points x $10 per point = $30
So, for a standard EUR/USD lot trade, the spread would be $30.
So, to turn this knowledge into real profits, follow the general recommendations:
- Trade in those hours when it is most profitable.
- Currency pairs with low liquidity are a risk of encountering high spreads, so you should not dive into trading them if you are not ready for negative results.
- Look for brokers with lower spreads to keep the cost of each trade within an acceptable range.
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