FxBrokerReviews.org – Trading currencies at a predetermined exchange rate is a component of investing in the forex markets. The price of a currency in another currency is therefore quoted. The forex spread is the variation in exchange rates at which a forex broker sells one currency and purchases another.
Forex brokers, individual investors, hedge funds, central banks, and governments are just a few of the numerous participants in the $5 trillion daily trading volume of the foreign exchange market. Currency demand, exchange rates, and the forex spread are all impacted by this trading activity.
Understanding Forex Trading
Buying and selling currencies at their current exchange rates is known as forex trading or FX trading, and it is done in the hopes that the exchange rate will move to the investor’s advantage. For instance, traders can purchase euros at the current exchange rate, or “spot rate,” in exchange for dollars, and then sell the euros to close the sale. A trader’s profit or loss on a transaction is determined by the difference between the purchase rate and the sell rate. Understanding how currencies are quoted by FX brokers is crucial before looking into forex spreads on FX trading.
What is a Spread in Forex?
Although there are no commission fees for trading the majority of forex currency pairs, every trade you make will incur a spread fee. All leveraged trading providers will add a spread to the cost of placing a trade in place of a commission since they account for a greater ask price compared to the bid price. The currency pair you are trading and its volatility, the amount of your deal, and the provider you use can all have an impact on the spread’s magnitude.
Some of the major major forex pairs include:
- EUR/USD: Euro and US dollar
- USD/JPY: US dollar and Japanese yen
- GBP/USD: British pound and US dollar
- USD/CHF: US dollar and Swiss franc
Also read: What is Forex? A Comprehensive Guide to Foreign Exchange Trading
Types of Spreads available in Forex
The kind of spreads you’ll see on a trading platform relies on the forex broker and how they generate revenue.
There are two types of spreads:
- Fixed
- Variable (also known as “floating”)
Variable spreads are provided by brokers running a “non-dealing desk” model, whereas fixed spreads are often provided by brokers that operate as market makers or “dealing desks.”
Fixed Spread
Regardless of the state of the market at any particular time, fixed spreads remain constant. In other words, the spread is unaffected by the market’s volatility, which might be compared to Kanye’s mood swings, or its calmness. Nothing changes.
Brokers that use the market maker or “dealing desk” business model provide fixed spreads.
The broker acquires sizable positions from their liquidity provider(s) and sells them to traders in smaller amounts through the use of a dealing desk.
Thus, the broker serves as the counterparty to the trades made by its clients.
Because they have control over the prices they show their customers, a forex broker with a trading desk is able to provide fixed spreads.
Also read: The Lowest Fixed Spread Brokers
Variable Spread
Variable spreads change continuously, as their name implies. Variable spreads cause a steady fluctuation in the spread between the ask and bid prices of currency pairings.
Brokers without a trading desk can provide variable spreads. Without the assistance of a dealing desk, non-dealing desk brokers obtain the pricing for currency pairs from a number of liquidity sources and pass these rates on to the trader.
Since they lack control over the spreads, they cannot. And depending on the supply and demand for different currencies as well as the general market volatility, spreads may expand or narrow.
Spreads typically increase as a result of the publication of economic data as well as other times when the market’s liquidity is reduced (like during holidays and when the zombie apocalypse begins).
Fixed Spread vs Variable Spread: Which is Better?
Depending on the trader’s requirements, fixed or variable spreads may be the preferable option.
For some traders, fixed spread brokers are preferable to those that offer variable spreads. Additionally, some traders can experience the opposite.
In general, fixed spread pricing is advantageous for traders with smaller accounts and fewer trades per month.
Variable spreads will also be advantageous for traders with larger accounts who often trade during busy trading periods (when spreads are at their narrowest).
Variable spread trading will appeal to traders who need quick transaction execution and must prevent requotes.
How Currencies Are Quoted?
The U.S. dollar and the Canadian dollar are two examples of pairs of currencies that are constantly cited. The base currency is the first one, and the counter currency, often known as the quote currency, is the second one.
The currency pair USD/CAD would be equal to 1.2500/1 or 1.2500, for instance, if it cost $1.2500 (Canadian dollars) to buy $1 (U.S. dollars). The base currency would be the USD, and the quotation or counter currency would be the CAD. In other words, the exchange rate is stated in Canadian dollars, therefore one US dollar costs 1.25 Canadian dollars.
However, several currencies use U.S. dollar terminology when expressed, making the USD the quotation currency. For instance, the quoted exchange rate of 1.2800 between the British pound and the U.S. dollar would be $1.2800 (in dollars) for each pound of sterling. The base currency, the pound, is denoted by the symbol GBP/USD.
Additionally, the euro is used as the base currency, meaning that if the exchange rate between the two currencies is 1.1450, it will cost 1.1450 dollars to buy one euro. In other words, a broker would quote the EUR/USD at $1.1450 to open a position.
How the Spread Is Calculated in the Forex Market?
Now that we are aware of how currencies are quoted in the market, let’s examine how to determine their spread. Similar to equities markets, forex quotations are always published with bid and ask prices.
The bid is the amount the forex market maker or broker is willing to pay to purchase the base currency (in this case, the USD) in exchange for the counter currency (CAD). The ask price, on the other hand, represents the cost at which the forex broker is prepared to sell the base currency in return for the counter currency.
The price at which a broker buys and sells a currency is known as the “bid-ask spread.” Therefore, the ask price would be given if a client requested a sell trade from the broker. The ask price is provided if the consumer wishes to start a purchase deal.
If a U.S. investor wishes to purchase or go long on euros, for instance, the bid-ask price on the broker’s trading website is $1.1200/1.1250. The investor would pay the asking price of $1.1250 in order to start a purchase deal. The asking price of $1.1200 per euro would be received by the investor (assuming there had been no change in the exchange rate) if they sold their euros back to the broker right away, unwinding their position. As a result of the broker’s bid-ask spread on the exchange rate, the speculative deal, therefore, cost the investor $.0050.
Also read: A Complete Guide To Forex Options Trading: Definition And How It Works
How are Forex Spread Quoted?
Here is an illustration of how the bid-ask spread may appear in a broker’s EUR/USD quote.
EUR/USD
| Bid | Ask |
| $1.1200 | $1.1250 |
| Sell | Buy |
Depending on the currency, spreads might be either narrower or broader. In our example, the bid-ask spread for EUR/USD is 50 pip, which is a large and unusual spread. Between the two prices, the spread typically ranges from one to five pip. But depending on market conditions, the spread could change or fluctuate at any time.
Investors must keep an eye on a broker’s spread since each speculative deal must pay the spread and any associated costs, or generate a profit large enough to do so. Furthermore, each broker has the option to increase their spread, which raises their profit per deal. When the bid-ask spread is greater, a consumer would have to pay more when buying and less when selling. In other words, any forex broker may impose a little spread charge that raises the price of currency transactions.
What’s a good spread in forex?
To learn what a decent spread in forex looks like, you may observe the most liquid forex pairings. The popular currency pairings are USD/JPY and USD/GBP. The spreads of such combinations may be contrasted with other pairings. To make sure you’re getting the greatest bargain, it could also be helpful to check spreads amongst brokerages.
How Do Exogenous Events Drive Forex Spreads?
Other variables outside the broker might expand or reduce a currency spread.
1. Time of Day
An important factor is the time of day a deal is started. For instance, Asian trading begins late at night for American and European investors, whereas European trading begins early in the morning for American dealers. In comparison to booking a trade during the European session, if a euro deal is made during the Asian trading session, the forex spread is likely to be substantially wider (and more expensive).
To put it another way, if the currency’s trading session is not regular, there won’t be many traders trading it, which will result in a lack of liquidity. Because there aren’t enough market players, a non-liquid market prevents easy buying and selling of the currency. The possibility of a loss if they can’t get out of their position is taken into consideration by forex brokers by widening their spreads.
2. Events and Volatility
Forex spreads might also get bigger due to geopolitical and economic developments. For instance, the dollar’s value relative to the majority of currencies would probably decline if the U.S. unemployment rate turned out to be significantly higher than expected. When events are happening, the forex market can change rapidly and become highly turbulent. Thus, because of the rapidly fluctuating nature of currency prices, forex spreads may be very large during events (called extreme volatility). A forex broker may find it difficult to determine the true exchange rate during periods of event-driven volatility, which forces them to impose a bigger spread to cover the increased risk of losing money.
What determines the Spread of Forex?
Market volatility, which can lead to fluctuations, is one factor that might affect the forex spread. For instance, important economic factors can influence the spread by causing a currency pair to gain or weaken. Currency pairings may gap or become less liquid in a tumultuous market, which will result in a wider spread.
You may be ready for the potential for bigger spreads by keeping a watch on our FX economic calendar. You may accurately forecast if currency pairs’ volatility will rise and, consequently, whether you will observe a wider spread, by remaining informed about the events that might make them less liquid. It might be challenging to plan for breaking news or unexpected economic data, though.
Lower spreads are probably available during the main forex market sessions in cities like London, New York, and Sydney. The gap can be much less when there is an overlap, such as when the London session ends and the New York session starts. The supply and demand of currencies in general also have an impact on the spread; if there is a large demand for the euro, the value will rise.
Final Thoughts
The difference between the ask price and the bid price of a currency pair is known as a forex spread, and it is often expressed in pip units. When trading forex, it’s important to understand what circumstances lead to the spread widening. Major currency pairings trade often and so have a narrower spread than exotic pairs, which have a wider spread.
