Meaning of Spread in Forex
Spread is the difference between the price you pay to buy a currency pair & the price you will be paid when you eventually sell the currency pair.
Spread is expressed & measured in pips
The buy & sell prices are never the same except your broker is offering you zero spread.
The buy price is always higher than the sell price.
This means when you want to buy a currency pair from your broker, you pay him more than what the pair is currently worth.
However, when you want to sell to your broker, he pays you less than what the pair is currently worth in the market.
If a Buy/Sell price is quoted as 1.0831/1.0832, the spread is (1.0832 – 1.0831) = 0.0001 or 1 pip.
Why is Spread Important in Forex?
Spread Affects the Length of Time You Spend Trading
The wider the spread, the longer it takes for your trade to break even & reach profitability. This means you spend a longer time in the market.
The longer the time you spend in the market, the higher your chances of sustaining a loss especially if your account balance is small.
Your Stop Loss Can Be Triggered Without Price Reaching It
If your broker decides to widen the spread after you have set your Stop Loss, you discover that your Stop Loss gets hit even if price has not reached your specified stop price.
Spread Reduces Your Profits
Every time you open a new trade, you will notice you always start with a loss. This loss is actually the spread so a higher spread means you start with a bigger loss.
If your broker says spread on EUR/USD is 1.6 pips, it means you pay $16 to trade 100,000 units.
How is Spread Deducted When You Trade?
Spread is deducted when you open a trade & that’s why you start with a loss. If your trade becomes profitable, then you pay off the spread. However if your trade ends in a loss, the spread is deducted from your account balance.
Types of Spread in Forex
Variable Spread
Variable spread in forex means that the spread is not fixed & can be widened or tightened at any time without notifying you.
With variable spread pricing (which is what most brokers offer), the spreads can change at anytime. When fear & uncertainty is high in the market, your broker can widen the spread without notice.
Fixed Spread
Fixed spread in forex means the spread remains the same & is pegged to a specific number of pips. When opting for fixed spread, always check that it has not been inflated & is at par or even lower than industry averages.
Why Do Brokers Widen The Spread At certain Times?
Because of Volatility
Volatility refers to the level of turbulence in the market. When volatility is high, you can make higher profit as well as losses. This is because prices tend to reach record highs/lows when volatility is excessive.
During volatile market conditions, the broker will widen their spread to get a piece of the action; so that if you make a big profit, you also pay big spread.
Events such as release of important economic data can cause the markets to go into a frenzy & react turbulently, thus increasing the level of volatility.
Because of Low Liquidity
Low liquidity in forex simply means a period when there aren’t enough traders in the market.
Without a good number of traders in the market, your broker will charge you a higher spread to compensate for the inconvenience they face as they have to find a way to execute your trade.
The market can witness low liquidity in the night from 10pm because people are asleep. You may also witness low liquidity when trading certain unpopular currency pairs.
Fixed vs Variable Spread: Which is Better?
Beginners should consider going for fixed spread because it is more transparent & cannot be widened suddenly by the broker.
Professionals using automated trading strategies should consider variable spreads. You need to be careful when choosing a broker based on variable spread.
Some brokers who claim to offer low variable spread on standard accounts, turnaround and engage in widening the spread during trades.
If you opt for variable spread you should consider asking your broker to give you raw spreads which have not been tampered with.
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