WHAT IS SPREADS IN FOREX MARKET
When a person choose to initiate doing trade in foreign exchange market, usually there must be some questions around spreads and how some accounts have spreads and how some accounts have lo spreads.
In this article, we will try to cover what spread is?, to get a better understanding of this concept of Forex.
WHAT IS SPREAD
We can define spread as the friends between the bid(sell) and ask(buy) price of a currency pair. Spread can be measured in pips( point in percentage) which is the smallest unit of price movement of a currency pair.
The purchase price will always be higher than the ceiling price, which means that in, financial market time and price matter the most.
KEY TAKEAWAYS:
1) Spreads are based on the buy and sell price of a currency pair.
2) costs of the currencies are based on spreads and sizes of lot.
3) spreads in forex keep fluctuating and should be referenced from your trading platform.
UNDERSTANDING SPREADS IN FOREX MARKET
Now let us understand the type of spreads in Forex along with an example for better learning. So before calculating the cost of a spread but that the spread is just the ask price - the bid price of a currency pair.
There are always 2 prices given in a currency pair, the Bid and the ask. Bid price is the price at which you can sell the base currency and ask price is the price you would use to buy the base currency.
When there is a wider spread, it means there is a greater difference between the prices so there is usually low liquidity and higher volatility.
And lower spread indicates low volatility and high liquidity. Thus, there will be spread incurred when trading a currency pair with a tighter spread.
There are two basic terms related to the spread that are:
a) Liquidity:
It refers to how active a market is. It is determined by how many traders are actively trading and the total volume they are trading.
b) volatility:
it is the measure of how extremely a market's prices change. Markets liquidity has a big impact on how volatile the market's prices are.
On this note we can understand the types of spreads. So there are two types of spreads that are:
1) Fixed spread:
A fixed spread is when the broker guarantees that no matter what happens in the market, the spread will remain the same. As if the spread on EUR/USD was 1 pip, I will stay the same no matter what.
2) Floating spread:
It is based on the market demand. Similar to the price change rates of currencies, the spread can change by growing and lowering. The market then adjust it based on how many people continue to trade that currency pair.
EXAMPLE:
- Let us understand the concept of spread by taking example; suppose a trader buy GBP in lieu of EUR, so in this case ,EUR would be our base currency and GBP will be counter currency.
EUR GBP
1.1037 / 1.1039
Now after subtracting= 1.1039-1.1037= 2.
On this note we can say that the spread is of 2 pips.
- Let us take another example, if the quote of the GBP / USD currency pair is, bid= 1.2920 and ask= 1.2923, then spread= 1.2923-1.2920= 0.0003 USD.
Or simply 3 pips.
Here is a simple formula we can estimate spread costs. That is:
Spread cost= spread size* lot size* number of lots.
Let's estimate the spread cost from the example above. The size of the lot is $100000 .
{ 0.0003 * $ 100000 * 5 = $150 }
SPECIAL CONSIDERATION OF SPREAD IN FOREX MARKET :
while doing trade in Forex exchange, we also need to consider when to trade the USD /JPY , the USD/JPY has a lot of volatility. One of the most liquid times to trade forex in generally is between 8:00 a.m and 11:00 a.m eastern time, when london and newyork session overlap. The USD /JPY also is highly liquid in the Tokyo session.
CONCLUSION:
basically the spread is most important cost in Forex trading. A new table broker that charges reasonable spreads and offers responsible leverage is the best option for and trader to have experience.
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