What is forex spread? How to calculate Spread in Forex?
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Spread is one of the most basic terms in stock trading and investing. This term is very familiar to traders in the forex market. But if you are a new trader, you must understand what spreads are to be successful. This article will learn what forex spread is, their importance, how they are calculated, and more.
What are spreads in Forex? What is Bid-Ask Spread?
Before learning how to calculate spreads and understanding their importance in stocks, traders need to understand what spreads are?
In the Forex market, the spread is the difference between the bid and ask prices. In other words, the forex spread represents the difference between the demand and supply prices (Bid and Ask) of a given financial asset.
The selling price is always higher than the buying price. Therefore, if a trader opens a trading position and then closes it immediately, the trader will surely lose a loss equal to the spread.
Therefore, when opening a trading order, traders need to wait until the market moves in the direction they want with an amount equal to the spread or larger to profit.
In addition to commissions and swaps, the spread is also one of the brokers’ primary sources of income. Spreads or spreads can be fixed or floating, but often online stock exchanges offer floating spreads.
Forex Spreads and Pip
The spread difference between the bid and asks prices are expressed in “pips” or “points.” A pip is the 4th decimal in the currency market after the integer part of the exchange rate (except for the Japanese Yen, which has only two decimal places), and Forex Spread is measured in pips.
Let’s say the GPB/USD currency pair is trading at 1.29300/1.29310. The difference between the bid and ask prices here is 0.0001 – which equates to a spread of 1 pip.
Forex spreads change according to price movements and depends on each broker. The most traded currency pair is Euro vs. US Dollar (EURUSD). Therefore, the spread of this currency pair is usually the lowest.
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How to calculate Spread in Forex?
Forex Spread is measured in pips, so how can we calculate Spreads according to currency value.
The monetary value of the spread depends on the trading volume, as the trading volume determines the size of each pip.
In Forex, the formula for calculating the one pip value of the quote currency (2nd currency in the currency pair) is 0.0001 multiplied by the trading volume.
Example of how to calculate Spread in Forex.
When trading one lot of GPB/USD, we have:
- 1 lot GPB/USD = 100,000 GBP
- Value of 1 pip GPB/USD = 100,000 x 0.0001 Units of Valuation (USD) = 10 USD
Put, for all currency pairs (except for the Japanese Yen), the value of 1 pip of 1 traded lot will be ten units of the quote currency. Like the example above, the value of 1 pip of 1 lot of GPB/USD is 10 USD.
For currency pairs with the quote currency of the Japanese Yen, the pip will be the 2nd decimal place after the integer part of the exchange rate. That means we will multiply the trading volume by 0.01 instead of 0.0001 as the original formula.
Based on the above example, when we calculate the spread by one pip, we can say that the Spread fee of 1 traded lot is 10 USD.
What are the factors that affect forex spreads?
Spread is affected by the following factors:
- Liquidity of financial assets
- Market conditions
- The volume of financial assets traded
Spreads depend on the liquidity of financial assets. The more assets are traded, the more liquid the market is. This means the closer the gap between supply and demand, the lower the spread. In low-liquidity, less-traded markets like natural gas, spreads are often higher.
Spread can change according to market conditions: It is usually higher when macroeconomic information is released or when the market is volatile.
If a trader trades when the Federal Reserve or the European Central Bank has a press conference, making important economic statements, the spread is usually higher.
Some brokers offer fixed spreads. But when economic events are announced or volatile market, most brokers cannot guarantee a fixed spread.
Trading volume also affects the spread. If a trader’s trade is so large that it causes the market to move in the opposite direction, then market makers must adjust the spread to compensate for the increased risk they are taking. However, the reality is that the forex market is so liquid that it is difficult for a retail trader to impact the market price.
The importance of forex spreads
To become a successful Forex trader, traders must find the trading strategy that suits them best. A trader can accept spreads depending on the trading style and technique they choose.
For day traders use scalpers strategy, the spread plays a vital role. These traders participate in the market many times a day. If the spread is high, their profits can be severely affected.
The longer the trading time frame, the lower the effect of the spread on the profit earned. For example, if a swing trader makes profits that accumulate over days, weeks, or even months, the spreads that affect them are very low compared to the size of the movements in the markets they are operating wait.
Traders entering and exiting trades frequently can see spreads add up quite a bit. Therefore, if this is the trading style that the trader is adopting, then the trader needs to place an order when the spread is optimal.
Conclusion
Forex spread is the most fundamental concept in stock trading. Traders should care about spreads, but how much they care depends on the trader’s trading strategy.
The shorter the trading strategy, the more often it trades, the more traders should pay attention to the spread. If you are a scalper or day trader, then the spread will significantly affect profits and losses. The lower the spreads, the higher the yield.
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