What Can Traders Learn from a Forex Spread?
The basics of forex spreads are outlined below.
- The buy and sell prices of a currency pair are used to calculate spreads.
- The fees are calculated using forex spreads and lot sizes.
- Spreads on foreign exchange are variable and should be checked from your trading platform.
FX spreads are the primary cost of trading currencies, so traders should be familiar with them. We’ll look at how forex spreads work, how to calculate costs, and how to monitor changes in the spread to improve your trading results in this article.
IN FOREX TRADING, WHAT IS A SPREAD?
Every market, including forex, has a spread. A spread is the price difference between two places where a trader can buy or sell an underlying asset. Traders who are familiar with stocks will refer to this as the Bid: Inquire about the spread.
An example of a forex spread calculation for the EUR/USD is shown below. We’ll start by calculating the buy price, which is 1.13398, and then subtract the sell price, which is 1.3404. After this procedure, we are left with a reading of.00006. Traders should keep in mind that the pip value on the EUR/USD is the 4th digit after the decimal, resulting in a final spread of 0.6 pips.
Now we know how to calculate the spread in pips, let’s look at the actual cost incurred by traders.
HOW TO CALCULATE THE FOREX SPREAD AND COSTS
Before we calculate the cost of a spread, remember that the spread is just the ask priceless (minus) the bid price of a currency pair. So, in our example above, 1.13404-1.13398 = 0.00006 or 0.6 pips.
Using the quotes above, we know we can currently buy the EUR/USD at 1.13404 and close the transaction at a selling price of 1.13398. That means as soon as our trade is open, a trader would incur 0.6 pips of spread.
To find the total spread cost, we will now need to multiply this value by pip cost while considering the total amount of lots traded. When trading a 10k EUR/USD lot, you would incur a total cost of 0.00006 (0.6pips) X 10,000 (10k lot) = $0.6. If you were trading a standard lot (100,000 units of currency) your spread cost would be 0.00006pips (0.6pips) X 100,000 (1 standard lot) = $6.
If your account is denominated in another currency, like GBP, you would have to convert it to US Dollars.
UNDERSTANDING THE DIFFERENCE BETWEEN A HIGH AND A LOW SPREAD
It’s important to remember that the FX spread can change throughout the day, ranging from a “high spread” to a “low spread.”
This is due to the fact that the spread can be influenced by a variety of factors such as volatility and liquidity. You’ll notice that some currency pairs have a wider spread than major currency pairs, such as emerging market currency pairs. When compared to emerging market currencies, your major currency pairs trade in higher volumes, which leads to lower spreads under normal circumstances.
Furthermore, it’s common knowledge that liquidity can dry up and spreads can widen in the run-up to major news events and between trading sessions.
A high spread means there is a large difference between the bid and the asking price. When compared to major currency pairs, emerging market currency pairs have a high spread.
A wider spread than usual usually means one of two things: high market volatility or low liquidity due to after-hours trading. Spreads can widen dramatically before major news events or during major shocks (Brexit, US Elections).
A small difference between the bid and ask price is referred to as a low spread. Trading when spreads are low, such as during major forex sessions, is preferable. A low spread typically indicates low volatility and high liquidity.
KEEPING AN EYE ON THE SPREAD FOR CHANGES.
The news is a well-known source of market turbulence. Economic calendar releases are sporadic and depending on whether or not expectations are met, prices can quickly fluctuate. Large liquidity providers, like retail traders, do not know the outcome of news events until they are released! As a result, they look to widen spreads to mitigate some of their risks.
Margin calls can be caused by spreads.
You may be stopped out of your position or receive a margin call if the spread widens dramatically while you are holding a position. Limiting the amount of leverage in your account is the only way to protect yourself during times of widening spreads. During times of widening spreads, it can also be beneficial to hold onto trade until the spread narrows.
Take a look at our recommended forex spread trading strategies for more information on how to successfully navigate the forex spread.
TO TAKE YOUR FOREX TRADING TO THE NEXT LEVEL, READ ON.
If you’re new to forex, we recommend downloading our free beginner’s forex trading guide, which contains expert advice on the market and how to trade it.
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