In the world of Forex, there are a lot of terms that are used to describe different aspects. One of the common terms that keep on popping up is spread. This means the difference in selling and buying an asset. In Forex, it is the variation between the bid and the ask price. Let’s have a closer look at the spread in Forex trading.
Definition of “Bid” and “Ask”
The terms bid and ask, also referred to as bid and offer, is a two-way price that refers to the possible price at which a security can be sold. The bid price represents the maximum price that a buyer can pay for a stock or share.
“Ask” represents the minimum price that a seller would take in the same security or stock. A transaction occurs when the buyer and seller agree on the securities worth if the amount paid for the bid is not higher than the indicated bid and not lower than the indicated ask.
The difference between the two prices is referred to as the spread and is measured in pips. This represents the lowest unit price that a currency pair can achieve. One pip is equivalent to 0.0001 in most pairs of currency.
For instance, in a currency pair of EUR/USD that cost 1.1051/1.1053, the difference would be 0.0001. This difference shows a spread of 2 pips.
Types of Spread
There are two kinds of spreads. This includes the fixed and variable. Here is a detailed view of both kinds of spread.
A fixed spread is a constant value that does not fluctuate regardless of the changes in the currency. This kind of spread is common in currency pairs that do not vary, making an insignificant average spread.
Most spreads that are fixed are set for currency pairs such as EUR/GBP, USD/JPY, EUR/USD, and GBP/USD. There are a couple of advantages that result from a fixed spread. They include:
- Provision of predictability in the market
- Allows traders to depend on a strategy without worrying about unexpected variables
- Suitable for beginners since it offers a cheaper option due to its small regulatory capital.
Besides the benefits of fixed spreads, there are a couple of setbacks that one should know about. These setbacks are as follows:
- There are possibilities of getting requotes since your broker are unable to change the spread and accommodate new conditions in the market
- You cannot use it during scalping
Variable Spreads or Floating Spreads
This is a spread that the broker sets within the lower limit and can change depending on the currency value. There are a couple of advantages of variable spreads, as described below.
- It is rare to get a requote since the variation experienced in the spread accommodates changes in the market
- It offers better price deals with prices from different liquidity providers. As a result, traders can make a lot of profit due to the level of competition.
There are also a couple of setbacks associated with spreads that are variable. These disadvantages are as follows.
- Traders are usually in a blink of a change since the spread might appear profitable and within no time become a loss
- The spread value widens when the market is active and if there is increased liquidity. On the other hand, it is low when the market is inactive
- Variable spreads can limit unintentionally and trigger protective stops
What Affects Spreads in Forex Trading?
Several factors affect the spread in Forex. Let’s have a closer look at these aspects.
If there is a lot of participants in a market, the prices of the currencies usually get closer. Therefore, you might find a variation of 3-5 pips in popular pairs.
If you decide to trade rare currencies such as the Swedish Krona or the Canadian dollar, the figures might go up to 50 pips or more.
Situations of the Market
Some of the factors that affect the market include economic news, market panic-crash, statistical information, and others. Therefore, if any of these factors affect the currency’s county of origin, the market might fluctuate.
A lot of brokers limit or provide maximum spread size for a currency pair based on their schedule of their commission. Since this is how they make a profit, you would not expect to find a zero spread account in Forex trading. With the right knowledge of spread trading, it is easier to improve your trading skills. You can apply them to your advantage and achieve a lot from your trading. However, you cannot accomplish this without a good Forex trading platform.