Absolutely confused by spreads

Hello,

newbie here trying to learn about how everything behind the scenes works. I think I now understand how order book works with all the Bid and Ask prices.

However, I can’t grasp one thing - spreads.

  1. How is spread a profit for the broker? I think I’m confused by this because I don’t fully yet understand what happens when I actually make an order to buy e.g. 1 lot of EUR/USD. Does broker execute the order for me on my trading platform and immediately sells 1 lot of EUR/USD somewhere else with this liquidity providers (which have better rates than what I’m shown by my broker?) Then again, here comes question, how can I have “worse” prices if the prices are set by simply supply and demand of the market where I’m trading?

  2. During news and other events, it’s said that brokers can manipulate spreads to be high to discourage trading for the moment or to offset risk for them. How can they just “manipulate” spreads? I thought spreads are natural depending on where the next lowest Ask and highest Bid prices are. How can they for example change the price of EURUSD from 1.2000/1.2002 to 1.1980/1.2050 when there could be millions of orders among all those skipped values? What happens to those orders?

I would very much appreciate if someone could post a dumbproof example with numbers because I haven’t been able to google this one out haha.

Thank you!

Think of the bid/ask spread in terms of physical goods like at the supermarket. If you want to buy a loaf of bread at the supermarket, you will have to pay the ask price, lets say it is £1.00p. But the supermarket did not buy it from the bakery for £1, they only paid 60p. So the spread is 40p and that is the supermarket’s profit.

It makes no difference what other supermarkets are offering bread at or what they pay for it or how much profit they make. Also, even if there’s a national “market” price for bread, and this is only 90p, your broker is not offering bread at this price, they offer it at £1, and your deal is with them, so you can take it or leave it.

Okay, thanks! How about the spread widening e.g. during news?

How can they for example change the price of EURUSD from 1.2000/1.2002 to 1.1980/1.2050 when there could be millions of orders among all those skipped values? What happens to those orders?

The broker you deal with makes their own prices, their quotes. These are your guidelines, the orders in the market which the big banks have placed and the spreads they pay and the quotes they get are nothing to do with you.

Stick with what is important to you and your trading -

  1. your broker’s “normal” spread

  2. your broker’s “regular” but abnormally wide spreads

  3. how your broker’s charts are printed

  4. Normal spreads apply when the bulk of the forex market is trading as normal and it is neither just before nor just after London and NY opening/closing times.

  5. Around these times spreads can go to about 2x normal (and some brokers will reject new entries for short periods simultaneously) but as they occur every day this is fairly predictable. Spreads will also be wider during the overnight period, when both London and NY are closed and only Asia is trading.

  6. Charts don’t show spreads. They are usually based on the bid price only.

I understand that I don’t really trade with big banks on the Interbank market and that I only trade either with the people that are under the same broker as I am or against the broker itself. But I still somehow miss the underlying logic how my broker can suddenly change the spread from 2 pips to 10 pips just by will?

I will try to say my logic (I’m sure it’s dumb but I need to say it so that you understand what I mean haha), bear with me please!
EUR/USD is trading at 1.0000/1.0002, however upon waiting for big news, quotes are suddenly changed to like 0.9995/1.0005 (for example). Now, how can broker just do that out of nowhere? What happens with all the Bid orders that are above 0.9995 and the Ask orders that are over 1.0002? Wouldn’t they just automatically fill then? What is the actual purpose between changing spreads during news?

I’m really sorry, I’m sure this must sound absolutely retarded but for some reason my head just can’t wrap around that. I know I’m missing some important point that once I’ll know it’ll all just click. Could you maybe describe the situation with the news as I did but with your own and correct numbers (how the spreads change and the reasoning behind it).

Thank you so much!

Normally when price jumps across an order level, the order is either not triggered at all or is executed at the next best available price - depends on the order type and the circumstances - its a common experience amongst traders that you expect a nice profit from an open position that’s moved in your favour and then you find that because the spread widened (not shown on the chart) price hit your stop-loss and the position is long gone. C’est la vie.

The broker widens their spreads to reduce the risk of loss to themselves. Often its at times like market open / close or news announcements when the broker cannot be sure of price is going to rise or fall. So, going back to the supermarket - they’ve got bread at the ask price of £1 and this gives them a profit of 40p per loaf, as they buy it at 60p. But they think the price of bread is going to rise so they’ll have to pay more than 60p, so they increase their ask price to £1.20p to manage their risk. Of course, on your chart, price is still 60p…

You need people buying and selling to fill and they wont fill because sometimes there aren’t orders there or because of their liquidity they may not get those prices. Also because they know they may not get those prices or because price is moving so fast they protect themselves by widening spreads so you buy/sell at a price far from market price.

one question since the question is on spread confusion i also have one question
mt4 is showing me 20 for eurusd as spread value does it mean if i put a buy order
so if price moved above 21 pips then my profit is only 1 pip right? 20 pips brooker take?

Basically yes. If the spread is 20 pips, that means wherever you buy will be 20 pips above the chart price (assuming your broker used bid-price based charts like mostly they do). Therefore, when you want to sell, in order to make a 1 pip profit, price would have to have risen 21 pips.

(That assumes the spread remains at 20 pips. If you buy 20 pips above the bid and then the broker changes the spread by raising or lowering the bid price, then the price rise you need will be less or more than 20 pips.)