Forex is one of the most popular financial markets as it is active five days a week, 24 hours a day, and has high liquidity. Due to its up-and-running nature, traders must be cautious, alert, and aware of the volatility of trading costs, including the spread. The spread is the difference between the bid price and the asking price. It is also known as the bid/ask spread.
Many traders often wonder about the importance of spread in forex and whether the spread matters in forex while trading. The answer to this question is yes; it does matter.
This is because the larger the spread, the more commission a trader has to pay to its broker, which means lesser profits. This is why traders need to look for low-spread brokers so that they can earn as much profit as possible. You may find reliable zero spread brokers here, offering some of the best incentives and packages.
Traders should familiarize themselves with spreads, as they are the major cost involved when trading forex. This is why, in this article, we will be discussing what spread is, its importance, how to calculate it, and much more.
What Is Spread?
When trading on the stock exchange, you don’t perform the trade yourself, instead, you just place an order. An order is your wish to buy or sell an asset, such as a currency pair. It is the broker who performs the trade on your behalf. The broker makes money on the difference between the ask and the bid price.
The price at which you will be selling the currency is known as the “bid.” Similarly, the price at which you can buy the currency is known as the “ask.” The bid price is always lower than the asking price in the forex market. This difference in the values of the two prices is known as the spread.
This spread is the way through which brokers make money. Instead of charging separate fees for making the transactions on your behalf, they build their cost into the buy and sell prices of your currency pair. The brokers make money by buying the currency from you for a lesser amount than they sold it to you for. Similarly, they also make money by selling the currency at a higher price than they originally paid.
The spread is similar to when you go to sell an item at a shop. The shopkeeper will buy the item from you at a lower price than he intends to sell it for. For example, if he will be selling it for $700, the most the shopkeeper can offer you is $69 for him to buy that item. This difference of $1 is the spread.
Importance of Spread in Forex
Spread is one of the most important factors to consider when trading forex, as it affects the trader’s profitability to a significant degree. It refers to the cost a trader must pay to continue with or leave the trade. This is because the spread is the commission of the brokers who offer traders their services for transactions.
Spread can add up to a significant cost for the trader if he leaves the trade much before the profit of the trade covers the cost of their spread. This is why it is important to carefully analyze the spread when selecting a broker and while entering and exiting a trade.
The spread is also used as a tool for risk management when trading forex. It is used to calculate a trader’s potential loss when entering a trade. Hence, doing this can ensure that the amount they will be risking is only a small percentage of their total account balance,so you need to check it.
How to Calculate Spread?
Calculating spreads is no big deal and is very easy to do. It is measured in pips, which indicate even the slightest movements in the price of a currency set. One pip equals 0.0001 for most of the currency pairs. For example, the 2-pip for the EUR/USD could be 1.1051/1.053.
Let’s take the example of the EUR/USD currency pair. The price for which the pair is being sold is 1.3398, whereas the price for which it could be bought is 1.3404. So, to calculate it, you would have to subtract the bid (sell) price from the ask (buy) price. For this example, the spread would be equal to 0.00006 and 0.6 pips.
Similarly, to calculate the total cost of the spread in this trade example, the value, which is 0.00006, will be multiplied by the size of the lots being traded. For example, if the trader trades 10,000 units of mini lots, then the cost of the spread will be equal to $0.6.
To summarize the whole article, the spread is the difference between the ask and the bid price. It is a way through which zero-commission brokers earn their profits in exchange for their services. It is a very important factor to consider when choosing a broker and entering or exiting a forex trade, as it does impact the profitability of the trade to a significant extent.
Does the spread matter in Forex? Yes.