In forex, the spread is typically the difference between the buying price (ask) and the selling price (bid) of a currency pair. It represents the cost of executing a trade and is usually measured in pips, which is the smallest unit of price change in the forex market.
The spread can vary from one currency pair to another, as well as from broker to broker, and is influenced by various factors, including market volatility, liquidity, and instrument type.
What is a Good Spread in Forex?
A good spread in forex is one that is narrow, meaning the difference between the bid and ask prices is small. Smaller spreads are desirable because they minimize the cost of executing a trade and increase the potential profit.
Therefore, it is important to consider the spread when choosing a currency pair to trade and when deciding on the entry and exit points of a trade. In most cases, major currency pairs such as EUR/USD, USD/JPY, and GBP/USD have the narrowest spreads, usually less than 3 pips.
How is Spread Calculated in Forex?
You can determine a currency pair’s spread by subtracting its bid price from the asking price. For example, if the bid price of EUR/USD is 1.2000 and the asking price is 1.2005, the spread would be 0.0005 or 5 pips.
The spread can also be expressed as a percentage of the bid-ask price, which is known as the spread percentage. In the above example, the spread percentage would be 0.04%.
What Causes High Spread in Forex?
Forex spreads may be driven up by a number of factors, including low liquidity, high volatility, and low trading volume.
- When there is low liquidity, there are fewer buyers and sellers in the market, which means assets can’t be exchanged without large variances in price.
- High volatility means that the upswings and downswings in price are larger than normal. This often occurs during major news events and necessitates wider spreads, because it increases the risk and uncertainty of trading.
- Low trading volume can also contribute to wider spreads, because there is less market participation and less competition among traders.
What Causes Low Spread in Forex?
On the other hand, several factors can cause low spread in forex, including high liquidity, low volatility, and high trading volume.
- In times of high liquidity, trading activity is heavy enough to allow for a seamless buying and selling of assets.
- Low volatility means that price movements are more stable and predictable. This attracts more traders into the market, consequently allowing brokers to spread their costs across more people, with each trader incurring lower spreads.
- When the trading volume is high, you are more likely to find a forex broker with spreads close to zero, as they try to persuade more traders to participate in the market.
Conclusion
Spread is a crucial factor in forex trading that can significantly impact the cost and profitability of executing trades. Luckily, the increased competition among brokers has led to a general decline in forex spreads over the years.
Still, spreads are effectively unavoidable in forex trading and the key to success lies in understanding the different factors that determine the spreads of different instruments.