What is a Spread in Forex Trading?
Let’s imagine you’re in a foreign country and you want to exchange your money. There are two prices you’ll see at the exchange counter: one price to buy a currency and another price to sell it. This is similar to the Forex market.
- Bid: This is the price you get if you want to sell a currency.
- Ask: This is the price you have to pay if you want to buy a currency.
The difference between these two prices is called the spread. It’s like a little fee you pay for the convenience of the trade. So, when you hear “spread,” think of it as a small service charge.
Now, some brokers say they don’t charge commission, but they actually earn from this spread. It’s like when you sell an old phone to a store, and they buy it for a lower price than they’ll sell it to the next person. That difference in price is like the spread.
How Do We Measure This Spread?
We measure the spread in units known as ‘pips’. In the Forex market, a pip is a standardized unit of price movement. For most currency pairs, a pip corresponds to a change of 0.0001. However, there’s also a smaller unit called a ‘pipette’, which is one-tenth of a pip, making it 0.00001 for most currency pairs. When you hear or see prices quoted with an extra decimal place (like 1.10512 instead of 1.1051), that last digit represents the pipette.
Different Kinds of Spreads:
- Fixed Spreads: These don’t change, no matter how wild or calm the market is. This kind of spread is usually given by brokers who act as a middle-man between you and the big market.Pros: Predictable costs, so you know what you’ll pay.Cons: Sometimes, the broker might not let you trade at the price you want, especially when prices are changing fast. This is called a ‘requote’. It’s like agreeing to a price online, then getting to the store and finding out it’s changed.
- Variable Spreads: These change all the time based on how the market is doing. They’re provided by brokers who get their prices from various sources, so they can’t control the spread.Pros: No unexpected ‘requote’ surprises.Cons: If you’re a quick trader, the changing spread might affect your profits. Also, in very active market times, the spread might change very quickly.
Which is Better? Fixed or Variable Spreads?
It really depends on what you prefer. If you’re someone who doesn’t trade often or doesn’t have a lot of money to start, fixed spreads might be better. But if you’re trading a lot during busy market times, variable spreads could be your choice.
How Much Does the Spread Actually Cost?
To know how much you’ll pay, you have to know the value of each pip and how many you’re trading. If the spread is 1.4 pips and you’re trading a small amount, you might pay a small fee like $1.40. If you’re trading more, you’ll pay more.
Remember, always be aware of the spread, as it’s a cost you have to consider in trading. And always choose a broker that fits your trading style and budget.