What Is Spread In Forex: How to Understand and Choose the Best Spread for Your Forex Trading

Are you new to forex trading? “Spread” might puzzle you, but understanding it is vital for trading success.

In this blog post, we will explain how to calculate spread, what it is, and how to choose the right spread for your trading needs.

 An image illustration of spread in forex
An image illustration of spread in Forex

What is Spread in Forex

Spread in forex is the difference between the prices at which a broker allows you to sell and buy a currency pair.

You buy the base currency at the “bid” price and sell it at the “ask” price, forming the bid-ask spread.

The base currency is shown on the left of the currency pair, and the variable, quote or counter currency, is on the right.

The pairing tells you how much of the variable currency equals one unit of the base currency.

If the EUR/USD currency pair is quoted as 1.1850/1.1852, you can buy one euro for 1.1852 US dollars or sell one euro for 1.1850 US dollars.

The spread in this case is 0.0002, or 2 pips.

The spread is commonly measured in pips, representing the smallest currency pair price movement, typically the final decimal point (0.0001).

This is true for the majority of currency pairs, aside from the Japanese yen where the pip is the second decimal point (0.01).

Why is Spread Important in Forex

Spread is important in forex because it is one of the main costs of trading.

Every time you open and close a trade, you have to pay the spread to the broker.

The spread is how the broker makes money from your trading activity, as they do not charge any commission or fee.

The spread also affects the profitability of your trades, as it determines the break-even point of your trade.

The break-even point is the price level at which your trade neither makes nor loses money.

Calculate the break-even point by adding the spread to the entry price for a buy trade or subtracting the spread for a sell trade.

For example, if you buy EUR/USD at 1.1852 and the spread is 2 pips, your break-even point is 1.1854.

This means that the price has to rise above 1.1854 for you to make a profit.

Similarly, if you sell EUR/USD at 1.1850 and the spread is 2 pips, your break-even point is 1.1848.

This means that the price has to fall below 1.1848 for you to make a profit.

The wider the spread, the higher the cost of trading, and the further away the break-even point.

The narrower the spread, the lower the cost of trading, and the closer the break-even point.

Therefore, as a trader, you want to look for the lowest possible spread that suits your trading style and strategy.

 An image illustration of spread in Forex
An image illustration of spread in Forex

What are the Types of Spread in Forex

Forex has two spread types: fixed and variable.

Your trading platform displays the spread based on the broker’s operational model.

Fixed Spread

Brokers operating as market makers or using a dealing desk model typically provide a fixed spread that remains constant regardless of market conditions.

This means that the broker acts as the counterparty to your trade and sets the price of the currency pair.

Fixed spreads offer predictability and stability, making them advantageous for traders employing mechanical or automated trading systems.

The disadvantage of fixed spread is that it is usually higher than the variable spread, especially during periods of low volatility and high liquidity.

Fixed spread can also be subject to requotes, meaning the broker may reject your order if the market price changes before it is executed.

Variable Spread

Variable spread is a dynamic spread that changes according to the market conditions.

It is usually offered by brokers that operate as a non-dealing desk or an ECN/STP model.

This indicates that the broker doesn’t act as the trade’s counterparty.

Instead, it connects you to the interbank market, where currency pair prices depend on market participants’ supply and demand.

Variable spreads offer the advantage of potentially being lower than fixed spreads, particularly during periods of high volatility and low liquidity.

Variable spread can also reflect the true market conditions and offer more transparency and accuracy.

Spreads’ unpredictability and instability can be a drawback for traders implementing tight stop losses or scalping strategies.

Variable spreads can also lead to slippage, where your order may be executed at a price different from your request.

How to Choose the Right Spread for Your Trading

Choosing the right spread for your trading depends on several factors, such as your trading style, strategy, risk tolerance, and budget.

Here are some tips to help you choose the right spread for your trading:

Consider Your Trading Style And Strategy.

If you are a long-term trader who holds positions for days, weeks, or months, the spread may not significantly impact your trading, as the price movements will outweigh the spread costs.

Yet, for short-term traders swiftly opening and closing positions within a day, or even in minutes or seconds, the spread significantly affects trading, as it cuts into profits through spread costs.

Therefore, you may want to look for a broker that offers low or competitive spreads for your preferred currency pairs.

Consider Your Risk Tolerance And Budget.

For risk-averse traders favoring small amounts and low leverage, the spread might not raise significant concerns.

They can accept a higher spread for enhanced stability and security.

But for risk-seeking traders dealing with significant amounts and high leverage, the spread becomes vital.

They aim to minimize trading costs and maximize profit potential.

Therefore, you may want to look for a broker that offers variable or tight spreads for your preferred currency pairs.

Compare Different Brokers And Their Spreads.

Before you choose a broker, you should do some research and compare different brokers and their spreads.

You can use online tools or websites that provide live or historical spreads of different brokers and currency pairs.

One can also check the reviews and ratings of different brokers and their services.

You should look for a broker that offers the best combination of low spreads, fast execution, a reliable platform, and excellent customer support.

Summary

Spread in forex is the difference between the buy and sell price of a currency pair.

It is one of the main costs of trading and it affects the profitability and risk of your trades.

There are two types of spread in forex: fixed and variable.

A fixed spread remains constant irrespective of market conditions, while a variable spread adjusts based on market conditions.

Choosing the right spread depends on your trading style, strategy, risk tolerance, and budget.

You should compare different brokers and their spreads and look for the best option that suits your trading needs.

Conclusion

In this blog post, I have explained what spread is, how it is calculated, and how to choose the right spread for your trading needs.

I have also discussed the different types of spread in forex: fixed and variable, the advantages and disadvantages of each type of spread, and how they affect your trading style, strategy, risk tolerance, and budget.

I hope you have learned something new and useful from this post, and that you will apply this knowledge to your forex trading.

Remember, the spread is one of the main costs of trading, and it can have a significant impact on your profitability and risk.

Therefore, you should always compare different brokers and their spreads, and look for the best option that suits your trading needs.

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