What is a Spread in Forex Trading – and How do you Read It?
While learning about Forex trading, one of the terms you will come across is “spread.” What is spread and Forex, and what does it mean? The simplest explanation would be that a spread in Forex represents the difference between the bid and the ask. It means the difference between the selling price and buying price of a specific currency pair of your choice.
How to Decipher a Spread
Since we are talking about pairs of currency, it makes sense there will be two prices included. One will be the bid price (selling), and others will be the asking price (buying). The first one decides the price at which you can sell the first in the pair, and the other one is the price you will use to buy the base currency, which is on the left side when you are looking at a currency pair. What we call the “variable” is on the right side. Together, they show you how much of the variable currency is equal to buying one unit of the base currency. What you should already know is that the buy price will always be higher than the selling price, while the underlying market will be something between that number.
Currency pairs are commonly traded without commission, and that’s why the spread has to be one cost that applies to any trade that you want to place. This is the way trading providers incorporate the cost of placing a trade, having in mind that the higher the risk, the bid price is going to be higher as well. What about the size of the spread? It’s affected by many factors from the way you are trading to their volatility. It also depends on which service you are using to buy a spread. Top Forex pairs are, for example, EUR/USD, GBP/USD, USD/JPY, and USD/CHF.
How is the Spread Measured?
“Pip” is a general term in Forex, and it is a small movement unit in the currency pair price, which is how the spread is measured. The price’s last decimal on the price quote is very important because it is that “pip” on the price quote. The only exception is the Japanese yen (JPY), where you have pip as the second decimal point (0.01), while in the other currency pairs you will have 0.0001. The wider the spread, the more significant the difference between the two prices. What does this imply? It implies there is high volatility included. When it’s the opposite, the liquidity will be higher, while the volatility will be lower. The tighter the spread, the more value you get as a trader.
Types of Spreads
Spreads can be variable or fixed. While indices have fixed spreads, Forex pair spreads are variable. This means that when the bid and ask both change in a currency pair, the whole spread will change as well. Whichever spread you choose, there will be pros and cons. For example, with a variable spread, there are no risks of requotes. But it will suit experienced traders better. Fixed spreads have predictable transaction fees, and they won’t be exposed to changes very easily if the market is volatile. But, they are very likely to be exposed to slippage.
What does a Forex Spread Indicator Look Like?
Forex spreads are usually represented using a graph as a curve that shows the direction of a spread. Many things can influence the market volatility, thus the Forex spread, which is usually economical. That’s why it’s important to be informed, follow the news, and apply different trading times. There are economic calendars online that can help you with that. Usually, when there is a trading time overlap, the spread will go narrow, as an example.
Spread and Margin
“Margin call” is another important term when we talk about Forex spreads. A margin call will happen if the Forex spread widens a lot in a very short amount of time. This means your account value probably dropped below 100%, wherein the worst case the spread can be liquidated. If the Forex spread widens dramatically, you run the risk of receiving a margin call, and worst case, being liquidated. A margin call is there to warn you that you are not covering trading requirements.
This is exactly why the size of your position should be considered wisely. Your account balance can easily be shaken if you don’t pay attention, since Forex pairs are mostly traded in much larger amounts than shares.
We explained what a Forex spread is and how it’s measured (in pips, remember?). We want to emphasize being informed so you can predict some factors that will affect a Forex spread, therefore change the difference between the bid and the asking price of a currency pair. Like anything in Forex, constant education and willingness to learn is vital if you want to improve. Another tip is to have a smaller trade if you’re going to trade with top currencies (major currency pairs) since people are trading them in high volumes. If and when you start trading with exotic currencies, once you have more experience, you can have a wider spread if you are using that type of currency pair.
Ask your broker about whatever you want to learn, and bear in mind that everything new looks overwhelming at first. But with practice, it will become easier very quickly. Don’t rush the process – you are still learning. By experimenting, you will get a better understanding of what everything is, and you will be able to make quality trades.
Get the latest economy news, trading news, and Forex news on Finance Brokerage. Check out our comprehensive trading education and list of best Forex brokers list here. If you are interested in following the latest news on the topic, please follow Finance Brokerage on Google News.