What Is A Forex Spread And Why Does It Matter?

September 6, 2022

Spreads are significant in the forex market. Generally, the forex brokers offer the spreads and thus can influence the entire trading platform. Novice traders must significantly understand the core concept of spreads before investing in the forex market.

What Are Spreads?

Spreads refer to the difference in the pips between the bid and the ask price of any forex currency pair. Typically spreads can be narrow or wide depending on the market position. Furthermore, spreads are a common way for brokers to earn money during transactions.

How to Measure Spreads?

Spreads are generally measured in pips. Any slightest price movement of the currency pairs is known as pips. Typically, for the majority of forex currency pairs, one pip= 0.0001

Types of Spreads

Usually, the spreads are provided by the forex brokers on trading platforms. Here are the types of forex spreads. These are as follows:

  • Fixed Spreads: By the name, it is pretty clear that these spreads remain fixed. Therefore, they don’t change regardless of the market conditions. The market volatility and stability do not affect spreads and thus they are fixed. Generally, fixed spreads are provided by the brokers that operate under the dealing desk model.
  • Variable Spreads: Variable spreads are the exact opposite of fixed spreads. These spreads get affected by market conditions. The market’s volatility and stability have a direct impact on the spreads. Therefore, the overall difference between the bid and ask price constantly changes. Non-dealing desk brokers usually offer these.

Spread Calculation

Spreads are generally related to the transaction cost. Therefore, the spreads affect a trader’s total cost while making any trade. The following are needed to calculate the full value of spreads:
-Value of each pip
-Total lots a trader is trading

Why Do Spreads Matter?

Spreads form an integral aspect of forex trading. In other words, it is ideal to mention that the entire forex trading is incomplete without spreads. Typically, forex brokers offer spreads to traders. The spreads affect the overall trading decision of the traders. Here are some reasons that make spreads extremely important. These are as follows:

  • Transaction Costs: Spreads are directly related to the transaction cost a trader incurs while trading in the forex market. Every forex broker offers different spreads, and thus the traders can easily differentiate the overall trading cost. The more the spreads, the higher will be the trading cost. Therefore, the traders will incur more and receive less. Hence, the traders, while selecting a forex broker, must understand the spread provided by the broker to determine the actual trading cost.
  • Manipulation: Many forex brokers manipulate the spread without getting consent from their clients. Thus, the traders remain unaware of the malpractice, and they have to face higher transaction costs. The situation is highly prevalent among novice traders. Therefore, inexperienced traders must first learn the concept of spreads in detail. It will enhance their knowledge and prevent them from falling prey to malpractices conducted by forex brokers.
  • Spread Size: Spread size has a significant impact on the comprehensive profitability and overheads of the trader. Generally, when the spread size is large, the market is highly volatile, and the trader may lose money. Some traders take the help of leverage; however, the market’s extreme volatility can cause them to lose more than receive benefits. Hence, the traders must have complete knowledge of spreads as they significantly influence the comprehensive profitability.

Selection of a Forex Broker

Spreads and forex brokers are correlated. When traders select a high-quality and well-recognised forex broker, they are more likely to receive a better spread policy. Besides, the brokers sometimes also manipulate the spreads, making the total transaction cost high for the traders. When selecting a forex broker, the traders must consider different aspects like liquidity, instruments, platforms offered, and spreads. These are essential points that govern the comprehensive trading policy of the traders.

The Bottom Line

Therefore, in a nutshell, it is fitting to mention that spreads constitute an integral element of forex trading. Thus, forex traders must understand the spreads before investing in the forex market. If a trader is associated with a high-spread forex broker, they are most likely to incur high transaction costs. Thus, it is critical to understand every core concept for laying hands on more profitable deals.

Author myfxstreet