Forex spread is one of the main costs you have when trading, so it is very important to take it into account when trading.
What is the Forex Spread and how is it calculated?
In this article we will look at what the Forex spread is and how it is calculated, and explain this in an easy to understand way.
What is the forex spread?
Forex spread always refers to the difference between the bid price and the ask price of a currency pair.
Let’s say you want to buy the EUR/USD currency pair from a broker.
The quote or the price at which the broker sells the EUR/USD currency pair is 1.16, which means that if you want to buy, you have to pay this price.
However, there are also people who want to sell EUR/USD, and the broker buys it from them at a lower price than he sells it. The rate for buying EUR/USD is 1.14.
The difference between the bid price and the ask price for the currency pair is the Forex Spread. In this case it is 0.02.
However, in Forex trading, the terms bid and ask are not used, but two terms are used to avoid possible confusion:
Ask. The term Ask refers to the selling price of a currency or the price a person must pay to buy the quoted currency. For example: Ask EUR/CAD 1.5087.
Bid. The term Bid denotes the retail purchase price of a currency or the price a person expects to receive when selling their currencies. Example: Bid EUR/CAD 1.5085.
How the Forex Spread is calculated
The spread is obtained by subtracting the bid price from the ask price of a currency pair. Only two pieces of information are needed to calculate the Forex spread,
the BID or bid rate of the currency pair EUR/CAD 1.5085
the ASK rate or ask rate of the currency pair EUR/CAD at 1.5087.
Now we calculate the difference between the two prices:
In this example, the spread would be 0.0002. In other words, the spread for this pair is 2 pips.
Types of spreads
Spread rates can vary depending on the trading platform used, the payment method, the execution time and other factors. However, the most common types of spreads are the fixed spread and the variable spread.
The fixed spread does not vary and is not affected by changes in market conditions. It is the same number of pips at any given time, as it does not take into account the volatility or stability of the market.
Advantages of the fixed spread
- Lower risk and better control over the invested capital.
- They are cheaper overall
- The trader knows the cost of the trade from the beginning.
Disadvantages of fixed spreads
Quick and frequent price changes: The broker can adjust prices when he sees fit.
Less transparency: since fixed spreads do not reflect market conditions in real time, they may offer less transparency in pricing.
A variable spread is a spread that varies in real time depending on market conditions.
Advantages of variable spreads
Possibility of lower costs: In times of high liquidity, variable spreads can be lower than fixed spreads, resulting in lower costs for executing trades.
Transparency: variable spreads reflect real-time market conditions and allow traders to access more accurate and up-to-date quotes.
Disadvantages and disadvantage of variable spreads
Transaction cost uncertainty: variable spreads can widen during periods of low liquidity or high volatility, which can increase transaction costs for traders and make it difficult to calculate before placing a trade.
Slippage Risk: Because variable spreads can change quickly, there is a risk of slippage (when an order is executed at a price other than the expected price), which can negatively impact the results of a trade.
Calculation of the spread and the cost of trading
The cost of trading includes all commissions, fees and interest charged by the broker or investment platform for providing its services. All of these costs must be added to the spread offered by the broker to determine the actual cost of trading.
Trading costs= broker commissions, interest and fees + forex spread.
Forex spread is the difference between the bid and ask price of a currency, taking into account the last decimal place used for its quotation.
The most common types of spreads include the fixed spread and the variable spread.
The fixed spread is constant and does not change with the market.
The variable spread is volatile, it changes depending on the market conditions.