Forex spread: its types and how it is calculated - GERCHIK & CO

The Concept of Forex Spread and How to Calculate It

17-12-2019

In order to be able to trade Forex, the traders need to have a trading account opened with a brokerage company that will give them access to quotes. For providing its services and solutions, the broker charges a spread fee, or a brokerage commission for opening a trade.

These commissions are one of the trader’s expense items, and so it is essential to know its size in order to plan out trading results. In this blog post, we are going to teach you how to find out and/or calculate the spread.

Content:

1. Is there a way not to pay the spread
2. How to learn the Forex spread
3. The difference between the bid and ask price is known as spread
4. What are the special aspects of fixed and floating spreads
5. Which spread is better: floating or fixed one
6. How to determine the spread

Is there a way not to pay the spread

Spread itself is the basic trading concept and is linked to unique features of access to financial markets. We cannot enter the stock exchanges on our own. This is what the brokers are for, acting as intermediaries between private traders/investors and the financial market, or the foreign currency market in our case. The trader pays a commission for each trade which is essentially the broker's remuneration.

People, who don’t know much about the stock exchange trading and the Forex market, encounter the spread when exchanging the foreign currency. The currency exchange table always shows two prices: a bid price and an ask price. The difference between them is a bank spread i.e. bank's revenue for making foreign exchange transactions.

This is why, it is hardly possible to avoid the spread in the Forex market. However, each trader can choose the terms that he or she is comfortable with. They may differ both in different brokerage companies, and within the same company, since the customers may be offered accounts with different types of spreads.

How to learn the Forex spread

The Forex spread is very similar to bank fees charged for currency exchange transactions. If we open the chart of any currency pair, we will see two prices. The bid price is what buyers are willing to pay for it. The ask price is what sellers are willing to take for it. Incidentally, the chart is built based on the bid prices.

What is a Forex spread: picture 1

The difference between the bid and ask price is known as spread

The size of the spread depends on the liquidity of the financial instrument and its market volatility. The higher the liquidity (i.e. the bigger the number of buyers and sellers in the market), the lower the spread. During the periods of increased volatility, it expands.

The spread can be either fixed or floating, depending on the terms offered by a particular brokerage company. There are brokers that offer the fixed spread, which means that the trader will always pay the same amount of money regardless of market volatility. When it comes to the floating spread, you will pay less when entering the market during low volatility. Conversely, you will pay more, when opening the trades during the release of important economic news which typically triggers increased volatility.

What are the special aspects of fixed and floating spreads

Back in the day when the brokerage companies were only starting to emerge, the spread was mostly fixed. The name speaks for itself: its value remained unchanged, regardless of the liquidity of an instrument and the market volatility. The size was determined by the forex broker, and typically exceeded the size of the stock exchange commission (the difference between the prices in the foreign exchange market).

After a while, a fixed spread has lost ground and brokers have made accounts with a floating spread available. That being said, the fixed spread remains popular among traders who opt for robotic trading. It is easier to tailor the robot’s operation algorithm to the fixed spread than having to adjust it to a floating one on and on.

The floating spread changes in the course of the trading session, yet it gained great popularity among traders. Customers are able to get a smaller spread for trades made during a calm trading session.

The size of the floating spread can range from 4 pips when it comes to the most liquid currency pairs, and up to 60 pips when there is a spike in volatility or in case of exotic assets. Accounts offering this type of spread work best for manual trading.


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Which spread is better: floating or fixed one

It depends on the trading strategy. If the trader prefers medium-term trading, opens few positions and takes profit from 50 pips or more, the fixed spread of several pips won’t make a big difference.

The floating spread can be a perfect choice for a scalper who makes many trades per day, as he or she will be able to choose the trade entries with minimum spread value.

If you are trading news when the size of the spread increases dramatically in the momentum due to increased volatility, the fixed spread will allow making more profit, whereas the floating one would eat up the lion's share of it.

How to determine the spread

Ask the brokerage company about the spread parameters of your account, whether it is fixed or floating. If the spread is fixed, the broker typically indicates the spread value for each currency pair in pips per one lot in the trading terms. You can have the pips converted into the deposit currency and receive the spread in money terms.

If the spread is floating, it can be calculated in the following manner. The smallest possible price move in the foreign exchange market is 0.0001.

Important!

So, to calculate the spread for one lot in money terms, you need to subtract the bid price from the ask price and multiply the difference by 10,000.

You can learn the current prices in the MetaTrader 4 trading terminal either in the “Market Watch” table for any instrument, or in the “New Order” window, where the top line shows the ask price, and the bottom line shows the bid.

What is a Forex spread: picture 2

In our case, the spread for the EUR/USD pair = $2 for one lot: (1,23070 - 1,23050) × 10,000 = $2. The value of the spread increases or decreases, if a trade is opened with a larger or smaller volume.


What to know:


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