You will have to learn the structure of Forex trading in general to understand what are spreads in Forex trading. The first thing is that all FX transactions are carried out using intermediaries. These intermediaries (brokers) do not work for free. Payment for their services is included in each transaction cost. The profit of an online broker is the difference between bid-price and ask-price. So, when you are trying to understand what do spreads mean in Forex, here is the answer.
Let's take a closer look at the nature and features of the spread in Forex trading. At the same time, you will learn the rules for calculating the spreads, the secrets of managing this value, and trading strategies based on it.
What is the spread in trading?
So, the difference between the bid and offer price is the answer to the question of what are spreads in Forex trading. The full spread Forex definition looks like this:
The spread meaning in Forex is explained as the amount that a trader pays to an online broker for carrying out a trade transaction. Also, the spread in Forex meaning looks like the difference between the buying and selling prices of a trading pair. At the same time, the buy price is always higher than the sale price, while the market price of the base currency is approximately in the middle between these values.
The size of the spread depends on the stability of the currency pair, its liquidity, volumes, and trading time. It also depends on the specific broker whose services the trader uses.
Types of Spread in Forex
Forex spreads are of two types: fixed or variable. When it comes to trading currency pairs, you are dealing with a variable spread as the bid price and ask price are constantly changing. News, events, and other factors cause volatility. This is not always convenient because there is a risk of a sharp expansion and slippage of the spread. At the same time, this option has its advantages: it is beneficial for experienced traders to work with it because it is quite possible to achieve a narrow spread rather than encounter a re-quotation.
The fixed option has lower capital requirements, offers stable and predictable transaction costs, and is unaffected by market volatility. However, on Forex, you can find a low-spread broker and save.
How to calculate spread in Forex?
To find out what is a good spread in Forex, you need to learn how to calculate the spread. Spread is a variable, unstable value, even for the same currency pair. So, the Forex spread cost is defined as follows: the selling price is subtracted from the buying price.
For example, in the GBP/USD pair trading at 1.3085/1.3087, the spread is 1.3087-1.3085=0.0002.
That is, the spread, in this case, is equal to 2 points.
The more points you receive in the calculation process, the wider (or higher) the spread, and vice versa. The task of the trader is to find narrow spreads since they lose less on such operations, and the trade itself is more accessible in this case. With trading experience, you won't have to remember all the time how to calculate spread in Forex — it happens automatically. As well as you can rely on the best Forex robots to cope with different trading issues.
Note! The spread just seems small. In the context of large trading volumes, these are significant amounts: from $10 for a standard lot.
How can you manage the spread in your trading?
The trader has the opportunity to minimize the cost of spreads. This is justified by the definition itself, what does spread mean in Forex? There are several main ways to achieve this goal:
- Trade at the most favorable time.
- Avoid low-liquidity currency pairs.
- Use the services of low-spread brokers.
A favorable period for trading is considered a time when competition and demand for a certain currency pair are increasing. At this time, market makers are narrowing spreads to capture the desired positions. A thinly traded currency has low demand and widespread, respectively. The peak of liquidity is observed between 13:00 and 17:00 London time. However, trading before or immediately after the publication of important news is extremely unfavorable. There is a tendency for spreads to increase at such times.
You cannot trade Forex without a broker. However, you always have the opportunity to choose the broker that offers favorable conditions. Usually, the higher the investor's deposit, the lower the transaction costs.
What determines the change of the spread in Forex?
The main reasons for the fluctuation of the spread are the following factors:
- Market instability;
- A change in the main economic indicators, which strengthens or weakens a certain currency pair;
- If a currency pair becomes less liquid, the spread widens;
- When major market sessions occur, the spread narrows.
Traders predict the possibility of a wider or narrower spread based on these and other factors.
The same signs will have to be mentioned when we define what is spread in cryptocurrency trading. In the case of cryptocurrencies, the same rules apply as when trading other currency pairs. In particular, a low spread indicates liquidity, and an imbalance in the asset market causes a widespread increase. Lack of liquidity occurs when there are few people trading, or it occurs under the pressure of manipulation and good or bad news. So, in the cryptocurrency sector, the same rules apply when it comes to the calculation of the spread and the reasons that impact it.
Forex spread trading strategies
What is the best spread in Forex? Of course, the trader is interested in paying a lower fee since the savings are part profit. Tracking low-spread opportunities is a trading strategy. Following it, the trader looks for optimal entry and exit points and tracks the latest news and other macroeconomic indicators. This strategy is called event-driven trading.
The Forex Spread Indicator is another good strategy for tracking the opportunity to take advantage of a low spread. The indicator is a curve on the chart that shows the spread direction.
The third option used by Forex traders is monitoring the spread and constant control over the account. This strategy helps eliminate or minimize the risk of getting a margin call or liquidation. A margin call occurs when the value of a trader's account falls above the 100% margin level. Reaching a level of 50% below the margin causes the possibility of liquidation of all positions.
How to choose a low-spread broker?
Forex brokers know best what is a Forex spread because they make money from it. Some brokers additionally charge a commission of 1.5-4.5 USD per spread. More often than not, additional commissions are available to those brokers who, at first glance, offer the most favorable conditions. Therefore, finding a broker with favorable rates is the primary task of a trader.
With all that, brokers with low spreads are in the market. A trader can use some tips and life hacks to find them. All recommendations boil down to the need to conduct research. The following criteria should be taken as the basis of the study:
- Analysis of Forex commissions.
- An available number of currency pairs.
- Availability of proven and reliable regulation of the broker's activity.
If by all parameters, the broker seems reliable, and, at the same time, it offers favorable conditions, it is worth moving to the next stage of research:
- Open a demo account.
- Test available platform tools.
- Pay attention to functionality and usability.
The third stage is to try trading for real money and make sure that the previous conclusions were true.
This process takes time but saves real money and risks, giving confidence in further cooperation. There are many ready-made reviews of platforms and sites on the Internet, as well as real reviews on independent web resources. You can further study this information before proceeding to trade. Some experts also offer ratings, where they rank low-spread brokers according to the criteria mentioned above. Compare their results with your own to make a final decision.
The Bottom Line
The spread Forex meaning is the difference between the buy and sale prices of a currency pair, and it is calculated in points or pips. Brokers provide their services to traders, receiving a spread as a fee for it. In turn, investors and traders are trying to manage costs. This leads them to seek profitable cooperation and form strategies that help to obtain maximum profit with minimum operating costs.