What are forex spreads?
FOREX Spread is is the difference between the Buy and the Sell price of any given asset (varies with every broker).
In one of the most common definitions, the spread is the gap between the bid (sell price) and the ask (buy price) of a security or asset, like a stock, bond or commodity. This is known as a bid-ask spread.
Brokers will tell you that most forex currency pairs are traded without commission, but the spread is one cost that applies to any trade that you place. However, rather than charging a commission, all leveraged trading providers will incorporate a spread into the cost of placing a trade.
Why is a spread taken?
A spread is taken to cover the broker’s cost for executing orders. It costs all brokers to place the trades on your behalf, not to mention the cost of developing the platforms, paying employees, marketing etc. It takes a large amount of money for a broker to operate, and this is partially financed by the spread taken from clients - a primary source of funding. Without it, brokers would risk not being able to be financially sustainable as they’d rely solely on traders losing money to earn profits.
How to calculate spreads in forex?
The impact of spread on trade profitability is often overlooked. Going from a 3-pip spread to a 2-pip spread may not sound like much, and going from a 2-pip spread to a 1.8-pip spread may seem even less significant. But in both cases, depending on your trading style, the impact on profitability can be huge.
When calculating the spread in forex, the most important thing you need to remember is that 1 pip will be equal to the 4th digit after the comma, or the 4th decimal place. For the following example, we will take a look at the most commonly traded pair on the forex market , the USD/EUR.
If you have a sell price of 1.12496, and a buy price of 1.12500, we can see that the difference is 0.00004. Taking our method above with the fourth number after the comma, this means the spread is equal to 0.4pips.
Every trade that occurs on a Forex trading platform will always include two traded currencies also known as a pair. Let’s take the British Pound (GBP) and the Japanese Yen (JPY) as a prime calculation example to calculate a sample spread cost that a potential day-trader might inherit for executing one trade. Let’s say the GBP is worth 140 Japanese Yen. You believe that the JPY will appreciate by 5 to 145 against the dollar so you place a buy order for 10 units of JPY.
The closest ask-price for 1 GBP is 142 JPY, so you then proceed to place your order. Meanwhile the JPY seller on the other side of the table may have a bid priced at 143. In this case the spread will be calculated as (143-142 YEN) x 10, or 1 Yen for 10 units.
You can also search the internet for various Forex spread calculators that will further assist you in performing simple calculations that will go a long way in putting you in the best possible position to minimize trading costs and maximize profits. You can join a forex forum to learn more about forex trading spread.
Forex spread calculator works this way:
Spread % = (ask price - Bid price) / ask price x 100
Input the Ask price
Input the Bid price