Understanding the Spread in Forex Trading

If you’re getting into forex trading, you’ll constantly hear the term “spread.” So, what exactly is it? Simply put, the spread is the difference between the price at which you can buy an asset (the ask price) and the price at which you can sell it (the bid price). This is often called the bid-ask spread.

Several factors influence the spread, including the current market situation, the volatility of a currency pair, and its liquidity. Major currency pairs like EUR/USD and GBP/USD typically have tighter spreads because they are traded in high volumes, meaning they have high liquidity.

How the Spread Impacts Your Trades

The spread directly affects your trading performance because it represents the cost of executing a trade. You always enter a buy trade at the higher ask price and exit at the lower bid price. To make a profit, the market must move in your favor enough to cover the cost of the spread.

For example, if the bid price for EUR/USD is 1.2000 and the ask price is 1.2002, the spread is 0.0002. A smaller, or “tighter,” spread makes it easier to become profitable, while a wider spread means the market needs to move further before your trade is in the green. Understanding this is essential for accurately calculating your potential profits and losses.

Types of Forex Spreads Explained

Brokers offer different types of spreads, and the one you choose can significantly impact your trading costs and strategy. Here are the main types you’ll encounter:

• Fixed Spreads: These spreads remain constant regardless of market conditions. Market maker brokers often provide fixed spreads, giving traders a predictable cost for their trades.
• Variable Spreads: Typically associated with ECN (Electronic Communications Network) brokers, these spreads fluctuate based on market liquidity and volatility. They can become very narrow in calm markets but widen significantly during volatile periods or when liquidity is low.
• Floating Spreads: This is a type of variable spread directly linked to underlying market conditions. While they can offer even tighter spreads than standard variable options in normal markets, they can also expand dramatically during extreme volatility.
• Guaranteed Spreads: This is a form of fixed spread where the broker guarantees it will not change, even in volatile markets. This offers traders certainty about their trading costs and is commonly offered by market-maker brokers.

Choosing a Broker with the Lowest Spread

When selecting a forex broker, the spread is a critical factor to consider. A broker that consistently offers tight spreads will help keep your trading costs to a minimum. Look for brokers that may provide variable spreads, which can narrow during periods of high liquidity.

It’s also important to compare the spreads across different currency pairs, as some brokers may offer tight spreads on majors but wider ones on others. Finally, don’t just look at the raw spread value. Always check for any additional commissions or fees the broker charges. The true cost of executing a trade is the spread combined with any other transaction fees, which gives you a full picture of your expenses.