What Is The Spread In Forex And How Do You Calculate It?
The forex market is a decentralized and over-the-counter place for trading global currencies. The market has several aspects like buying, selling, and exchanging. Besides, the market is also responsible for determining the exchange currency rates. The forex market is global and requires the knowledge of different technical concepts. One such technical aspect of the market is spread.
What Is Spread?
In a general sense, spread refers to the standard trading cost. It is the difference between the sell rate offered by the broker and the buy rate during the currency exchange. In a clear sense, it is the difference between the bid price and the ask price of a specific currency pair. The spread is generally measured in pips and is crucial to ascertain while dealing in the forex market. Pips are the minor market movements that primarily affect the bid or ask price, i.e. spreads.
Here Is An Example To Better Understand The Spread:
- Sell Price = 1.3085
- Buy Price = 1.3087
- Spread = 1.5
Typically, the forex trade consists of buying one currency pair and selling the other one. The left is the base currency, and the right is the quote currency. The bid price stands for the cost of purchasing the base currency, and the ask price stands for the cost of selling it.
Furthermore, the other important aspect while considering the spread is that the broker can enhance the bid-ask spread. It means that the trader will pay more while buying and receive less while selling.
The primary aspect while calculating the spread is to find the difference between the buy price and the sell price in pips. The trader must subtract the bid price from the asking price to find the difference.
- Tight or Wide Spread
Spreads are of two types: wide or tight. The widespread is high, while on the other hand, the tight spread is low. When the pips are more, the spreads become wide. However, traders generally prefer tight spreads. Tight spreads indicate affordability, and therefore the trade is finalized at a reasonable price.
- Market Volatility
When the forex market experiences fewer price movements, the spread becomes wide. However, on the other hand, when the market is highly volatile, the spreads become tight. In other words, spreads are primarily affected by market factors.
What Is High Spread?
Emerging trade currencies usually show high spreads. In a general sense, a high spread refers to a large difference between the bid and ask price. High spreads also indicate extreme market volatility, and they typically arise before a significant event like elections or dynamic business news.
What Is Low Spread?
On the other hand, the low spread highlights a minor difference between the bid and ask prices. It also indicates high liquidity and less volatility. The experts recommend that low spreads are the best time to trade in the forex market. There are plenty of brokers now that support this platform. Let’s look at some of the best brokers that offer low spreads.
Spreads And Margin Calls
For instance, if a trader is holding any position and suddenly the spread enhances, they will receive a margin call from their broker. Getting a margin call is not a good sign and thus may affect the trading capacity. However, there are ways to overcome it. The best possible way is to reduce the leverage applied.
Big Events And Spreads
Spreads are more likely to be affected during any significant event. For instance, when a piece of big news from the company’s end is about to be released, it dramatically influences the overall spread. Hence, many companies use economic calendars to detect significant market events. Therefore, it is best to look for spreads while trading in the forex market.
The Bottom Line
Many unprofessional traders don’t possess enough forex trading knowledge and thus lose major capital. Therefore, in a nutshell, it is fitting to mention that spreads are an essential part of overall forex trading. Besides, spreads also play a crucial role in selecting a broker. Additionally, the spreads also influence the profitability ratio significantly. Hence, the traders must be well aware of the concept of spreads, including high and low spreads. It is ideal for traders to learn in-depth about the spreads, pips, technical indicators, and several aspects to get higher returns and profits in the forex market.