Trading Forex means that you will be dealing with currency pairs – buying one while selling the other at the same time. Forex currencies are quoted in terms of their prices in another currency. The spread in the Forex trading market stands for the difference between the exchange rate at which a Forex broker sells a currency and the rate at which the broker buys the currency.
When you are trading Forex, you will notice that there are two prices shown. These are called the bid and ask prices and the difference between them is spread. In Forex trading, the ask price is the amount of money that the broker pays to sell a certain asset, and the bid is the amount of money that it is willing to pay to buy the same asset.
All of the activity in the Forex trading market is conducted thanks to the Forex brokers. For the services offered, these brokers are charging fees to maintain the stability of the server. In other words, the spread is the amount of money that you are paying to trade Forex.
But, this is not everything. There are many other things that investors should know about spreads. So, follow our comprehensive guide to Forex trading spreads and see how exactly they work and how they can influence your positions in the Forex trading market.
Forex spreads meaning in simple terms
As we have already said, spreads in Forex trading can be viewed as a type of commission that you are paying to use the services of the Forex broker. There are several different types of spreads available in the market, but the one that you will come across most often is the bid/ask spread. In the Forex market, as we have already said, the bid price is the buying price, while the ask price, is the selling price.
The bid price is what the broker is bidding to pay for the currency, while the ask price is the price that the broker is asking you to pay to get the same currency. In the simplest terms, spread in the Forex market is the difference between the bid and ask prices. You might ask why are there different prices for selling and buying, the reason for this is simple. Forex brokers need some type of income to make sure they are providing traders with stable services. For this purpose, one of the best things to do is to charge spreads and maintain the stability of the platforms.
This type of spread in Forex trading is known as bid/ask spread because of the way it is calculated. The bid and ask prices of the currency pair are also a great representation of the supply and demand of ac certain currency.
To better understand the main idea behind Forex trading spreads, it is very important to first know how exactly currencies are quoted by the brokers. As you might already know, currencies in the market are always quoted in pairs. For example, if you want to trade the US dollar against Euro, you will be trading the EUR/USD currency pair. The first currency, in this case, Euro, is called the base currency, while the second one, in this case, the US dollar, is the quote currency.
Calculating Forex spread rates
Now that you understand the general idea of currency quotation in the Forex trading market, it is time for you to learn a little more about the way spreads in Forex are calculated. As we have mentioned above, the quotes are always provided with bid and ask prices in the market.
The bid/ask spread is one of the simplest and most common spreads charged in the Forex trading market. If you are a trader who wants to initiate a buy trade, the ask price would be quoted. If you want to open sell order, the bid price will be quoted.
To make it simpler to understand, let’s discuss good forex spreads example. Say that you are a trader from the USA, and you want to open a long trade, meaning buy, on euros. You go to the trading platform and you see that the bid/ask price on the platform is $1.1200/1.1225. To open the buy position, you will be charged the ask price of $1.1225. If you sold the currency pair right away, you would pay $1.1200. This means that only based on the spread difference, it would cost you $0.0025 simply to initiate the trade.
Depending on the broker that you are using, the spreads can be narrower or wider. This also depends on the currency pair that you are using. For example, the spread that we have discussed above is 25 pips, which is very high for the currency pair. In most cases, the spread for this pair is very low, somewhere between one to five. However, keep in mind that the spread mostly varies according to the broker you are using, as well as the general market conditions.
Ways to limit Forex spread cost
Paying huge amounts of a sum of your funds to spreads can be very devastating for your final profits made in Forex trading. The majority of Forex traders around the world are trying to avoid paying huge amounts of money in spreads, and this happens for a reason. While a spread of a few pips might not sound as much, when you consider the fact that you are mostly buying hundreds of units of a certain currency pair and you are doing so with leverage, the cost of spread increase quite a lot.
Because of this, it should not come as a surprise that there are many Forex traders in the market who a trying to avoid paying high spreads as much as possible. There are several things that you can do to make sure that you are always paying the lowest Forex spreads possible.
First of all, one of the most helpful things to do is to choose wisely when it comes to deciding which currency pair you want to trade. Generally, the more people trade a currency pair, the less you will be required to pay in form of spreads. Because of this, it is very important to make sure that you are trading pairs that known for high liquidity, such as the EUR/USD for example, which is one of the most traded currency pairs around the world.
This currency pair is known for having one of the tightest spreads in the market. But, this is not the only thing that you can do. Another thing that can help you is to take your time before deciding which broker to trust. In most cases, Forex brokers offer traders information about trading conditions on their websites. It is a good idea to check out these conditions before you sign up and see how much spread you might have to pay to the broker.
Market hours & Forex broker spreads
Among many things that can influence the amount of spreads that you might have to pay is the market hours. The Forex trading market is open 24 hours a day 5 days a week, but a very interesting thing about the Forex market hours is that different markets are open at different times.
When some of the markets are open at the same time, the activity in the market increases drastically, which results in tighter spreads and generally better trading conditions. Because more people are trading when several markets are open at the same time, the liquidity increases, which lowers the spread.
Why are spreads so important for brokers?
The spreads in the Forex trading market are of utmost importance for Forex brokers. Brokers are companies that provide consumers with access to the Forex trading market and they must be financially sound in order to ensure that the services they provide are safe, secure, and trustworthy. Because of this, the brokers must have some type of income in order to provide adequate services. One of the most commonly used methods to generate income is charging spreads.
On the other hand, there also are some brokers who charge commissions on deposits and withdrawals, as well as account maintenance fees. Spreads are the most typically charged commissions for brokers to generate some type of income.
Types of spread in Forex market
There are numerous different types of spreads available in the Forex trading market. Depending on the Forex broker that you are using, you might be offered different types of them. All of the different spreads in the Forex trading market come with the same purpose, to earn the broker some income.
Other than that, the spreads in the Forex trading market come in different forms and sizes, yet the idea stays the same. Among the numerous Forex trading spreads available in the market are:
- Bid/Ask Spreads
- Yield Spreads
- Negative Spreads
- Z Spreads
- Option-adjusted Spreads
The most commonly used spread that we have already discussed in today’s guide is the bid/ask spread. This is the most commonly charged spread in the market offered by the majority of the Forex brokers in the market. Let’s discuss the remaining ones below.
This one is pretty similar to the regular bid and ask spreads. However, they are mostly calculated for different assets. For example, the most popular asset that this spread is associated with are bonds. While talking about Forex spreads comparison, we should also discuss negative spread.
A very interesting thing about this type of spread is that it is not negative for traders, but for brokers. This means that instead of paying the broker the spreads, you will be receiving them. The negative spreads are a guarantee that they can get the payout if the spread is negative. However, it should be noted that negative spreads do not always work. This is mostly available when you are investing in high-interest-rate currencies.
Are spreads the same as commissions?
When talking about Forex spread rates, there are many people who think that spreads are the same as the commissions. However, this is not true at all. While spreads are one of the best options for brokers to earn money, this is not an alternative for commissions. The commissions that a broker might charge are very different from spreads, and they vary from broker to broker according to the needs of the specific broker.
Fixed & Floating spreads
Generally speaking, spreads in Forex trading come in two different forms. There are Forex fixed spreads, which always stay the same, and the floating, regular spreads, that change according to the market conditions. In the Forex trading market, a fixed spread is when the broker guarantees that no matter what happens in the market, the amount of money you might have to pay in the form of spreads that you might have to pay will be the same.
So, if the broker says that you will have to pay a fixed spread of 4 pips for a certain currency pair, it will be the same for any situation, no matter what happens in the market. On the other hand, the floating spread depends on numerous factors, this includes market conditions, such as demand and activity. Just like the exchange rate of the currency pair, the floating spread is constantly changing.
Final thoughts on Forex broker spreads
Spreads are a huge part of the Forex trading market around the world. The majority of the Forex brokers globally charge traders spreads and the amount of money charged as spreads vary from broker to broker. Understanding Forex spreads is very important for Forex traders, as they will have to deal with it at some point in their career.
There are different types of Forex trading spreads available in the market, the most popular one of them is the bid/ask spread. In Forex, when you are trading a currency pair, there always are two prices shown. One of them is the bid price, and the other is the ask price. The difference between these two prices is what we call spread.
Frequently Asked Questions on spreads in Forex
What does a floating spread mean?
Floating spreads in the Forex trading market refer to the type of spreads that change according to the market conditions. These spreads are affected by a number of things, including the general market conditions, market hours, and many other factors. There also are fixed spreads available in the Forex trading market, which means that no matter what happens in the market, the amount of spread a trader might have to pay stays the same.
When comparing these two, it is very hard to say that any one of them is better than the other. It all depends on the Forex trader, as well as the asset they are trading.
What are bid and ask spreads?
In the Forex trading market, bid and ask spread is the most commonly used spread. It represents the difference between the highest price the seller offers and the lowest price the buyer will pay for the same asset. In most cases, as the demand increases, the bid and ask prices are closer to one another, resulting in Forex lowest spread.
