Last update 2020.08.06
In foreign exchange (forex) trading, the spread is the difference between the bid (sell) price and the ask (buy) price of a currency pair. The bid-offer spread, also known as the bid-ask spread, is another way of talking about the spread applied to an asset’s price.
There are always two prices given in a currency pair, the bid and the ask price. The bid price represents the maximum price that a buyer is willing to pay for a forex pair or security, whereas the ask price represents the minimum price at which a seller is willing to take for that same asset. Both of these prices are given in real-time and are constantly updating.
It is also important to understand that in forex trading, the base currency is shown on the left of the currency pair, and the variable, quote or counter currency, on the right. The pairing tells you how much of the variable currency equals one unit of the base currency.
The buy price quoted will always be higher than the sell price quoted, with the underlying market price being somewhere in-between.
The spread is measured in pips, which is a small unit of movement in the price of a currency pair, and the fourth decimal point on the price quote.
This is true for the majority of currency pairs, aside from the Japanese yen where the pip is the second decimal point.
When trading forex, or any other asset via a CFD or spread betting account, you pay the entire spread upfront. This compares to the commission paid when trading share CFDs, which is paid both when entering or exiting a trade. The tighter the spread, the better value you get as a trader.
The bid price is 1.1129 and the ask price is 1.1130 for the EUR/USD currency pair. If you subtract 1.1129 from 11.1130, that equals 0.0001.
As the spread is based on the last large number in the price quote, it equates to a spread of 1.0.
Types of spread
When trading, the spread can either be variable or fixed. Indices, for example, have fixed spreads. The spread for forex pairs is variable, so when the bid and ask prices of the currency pair change, the spread changes too.
Some of the benefits and drawbacks of these two types of spreads are outlined below:
Factors which can influence the forex spread
Usually, if the bid and offer prices are close together, it is considered a tight market, which means that there is a consensus between buyers and sellers on how much the asset is worth. Whereas, if the spread is wider, it means that there is significant difference in opinion.
The bid-ask spread can be impacted by a range of factors, including:
- Liquidity: This refers to how easily an asset can be bought or sold. As the liquidity of an asset increases, the bid-ask spread usually tightens.
- Volume: This is a method of reporting the quantity of an asset that is traded daily. Assets that have a higher trading volume will often have narrower bid-offer spreads.
- Volatility: This is a measure of how much the market price changes in a given period. During periods of high volatility, when prices change rapidly, the spread is usually much wider.
When there is a wider spread, it means there is a greater difference between the two prices, so there is usually low liquidity and high volatility. A lower spread on the other hand indicates low volatility and high liquidity. Thus, there will be a smaller spread cost incurred when trading a currency pair with a tighter spread.
Most forex currency pairs are traded without commission, but the spread is one cost that applies to any trade that you place. Rather than charging a commission, all leveraged trading providers will incorporate a spread into the cost of placing a trade, as they factor in a higher ask price relative to the bid price.
The size of the spread can be influenced by different factors, such as which currency pair you are trading and how volatile it is, the size of your trade and which provider you are using.
Some of the major forex pairs include:
Forex spread indicators
The spread indicator is typically displayed as a curve on a graph to show the direction of the spread as it relates to bid and ask price. This helps visualise the spread in the forex pair over time, with the most liquid pairs having tighter spreads and the more exotic pairs having wider spreads.
Keeping an eye on an economic calendar can help prepare you for the possibility of wider spreads. By staying informed as to what events might cause currency pairs to become less liquid, you can make an educated prediction as to whether their volatility might increase, and thus whether you might see a greater spread.
However, breaking news or unexpected economic data can be difficult to prepare for.
There will also be a lower spread for currency pairs traded in high volumes, such as the major pairs containing the USD. These pairs have higher liquidity but can still be at risk of widening spreads if there is economic volatility.
During the major market trading sessions, like London, New York and Sydney sessions, there are likely to be lower spreads. In particular, when there is an overlap, such as when the London session is ending and the New York session is beginning, the spread can be narrower still. The spread is also influenced by the general supply and demand of currencies – if there is a high demand for the euro, the value will increase.
Spread and margin in forex
If the forex spread widens dramatically, you run the risk of receiving a margin call, and worst case, being liquidated. A margin call notification occurs when your account value drops below 100% of your margin level, signaling you’re at risk of no longer covering the trading requirement. If you reach 50% below the margin level, all your positions may be liquidated.
It’s therefore important to gauge how much leverage you’re trading with and the size of your position. Forex pairs are usually traded in larger amounts than shares, so it’s important to remain aware of your account balance.
- A forex spread is the difference between the bid price and the ask price of a currency pair, and is usually measured in pips.
- Knowing what factors cause the spread to widen is crucial when trading forex.
- Major currency pairs are traded in high volumes so have a smaller spread, whereas exotic pairs will have a wider spread.
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Disclaimer: Forex and Contracts for Difference (CFDs) are complex instruments and come with a high risk of losing money due to leverage. Forex trading is not suitable for everyone. You should consider whether you understand how forex and CFDs work and whether you can afford to take the high risk of losing your money.
The forex brokerages displayed shall disclaim the overall performance of traders in their platforms. Oanda warns that 76.8% of retail forex traders lose money trading CFDs. XTB warns that 80% of retail forex traders lose money trading CFDs. The forex broker Fxcm warns that 69.66% of retail forex traders lose money trading CFDs.
The performances aforementioned are not related to Wiseinvest AI forex trading and AI forex signals system. You can check the performance of our AI forex system on our dashboard.