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How to Calculate Spread in Forex Trading
The spread is one of the most crucial notions to learn when it comes to trading Forex since it can make a notable difference in trading results. Today we will discuss what spread is and how much it affects the efficiency of trading.
What is a spread on an exchange?
The spread is the difference between the current best bid and ask prices of a currency pair. In essence, the spread is the commission charged by a broker to a trader for each opening of a trade (buying or selling an asset). The size of this commission is an indicator of market liquidity: the bigger it is, the lower is the liquidity level. For this reason, when trading popular currency pairs, the spread does not reach large sizes. The spread in trading affects the profitability of the strategy used, so it should be taken into account when placing orders. The lower the spread, the more profitable are the trading conditions for the trader. In the Forex market, the units of spread are usually expressed in pips rather than the money we are used to. For example, when the current EUR/USD quote is 1.08275/1.08279, the spread on this pair is equal to four pips. Measuring in pips is very convenient because it allows you to compare spreads on different trading instruments. The spread size depends on the selected currency pair. Some of them have a smaller spread, while others have a larger spread. Forex spreads are divided into fixed and variable. Fixed spreads have the same value regardless of the current market situation. The size of the variable spread directly depends on current circumstances, including important economic events at the moment, the supply/demand ratio, and the activity of traders. The most popular on the international Forex market is the variable one, which in emergencies can reach 50 or more points. The average range in a quiet market is from 2 to 5 pips.
How does spread work
To understand better how exactly spread works, let`s use an example. Suppose the buy price of 1 unit of a currency pair is equal to 1.24612, while the sell price of 1 unit of the same currency pair is 1.24582. The difference in points is 30 points (for 5-digit quotes). This is the spread value. If measured in money, the spread is 0.003 dollars. Every time a trader opens an order, he gets a negative spread. That is, at the moment of opening a position, the trader always finds himself in a losing situation immediately. If we take the example described above, then when buying this currency pair, to get the minimum profit the pair must grow at least 31 points (30 points of spread + 1 point of profit). Each trader should know-how is spread calculated when trading in the Forex market. To calculate the spread on a currency pair expressed in points, you need to determine the difference between the bid and ask and take into account that one point equals one ten thousandths of the difference between prices. That is, the calculated number should be multiplied by 10000. OR, not to overcomplicate, you can simply use a broker spread calculator over here. When opening any trading position, a beginner trader should pay attention to the spread size. The commission can sometimes be several times greater than the minimum spread. Brokers exist and get the main profit exactly due to the size of the spread. The company sets the allowed values of the spread to facilitate the liquidity of a currency pair. At the time when the set limit is exceeded, the trading stops. For a trader, naturally, it is better when the size remains unchanged. Therefore, it is recommended to always ask the broker for the spread size for each currency asset. When working with currency pairs that have a low spread, it is necessary to be very careful, because the spread can increase drastically before the publication of data concerning serious changes in the world economy.
Importance of spread in Forex
Foreign exchange spread plays an important role since it predetermines the whole range of trading aspects: the choice of a broker, creating a trading strategy and the potential profit. A lot of trading systems and strategies are extremely conditioned on the spread offered by the broker, and often a spread value that is too high may make any trading system ineffective. If the trading system requires you to open multiple positions in a short time, then probably you will need to look for another broker with better spreads. That is why scalpers or those who trade very frequently check a currency exchange spread of each broker with utmost prudence. Moreover, currency exchange spread is a significant circumstance in deciding which currency pairs to work with because you are unlikely to trade GBP/ZAR with the spread 250.
It is important to remember that spread on the Forex market is a variable, the size of which depends on current events, trading conditions offered by broker, liquidity provider, etc. When choosing the best trading conditions, and, first of all, the size and type of spread, you determine the success of your activity in the Forex market. However, the low spread does not always provide favorable trading conditions, as a brokerage company may charge traders additional commission, the size of which may be quite large.
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