Understanding Forex Spreads
What is Meant By Forex Spreads?
Forex spreads basically refer to the difference in the bid price and the ask price for a specific currency type. In other words, a forex spread is the difference between the selling price and buying price when trading and exchanging currencies. There are various factors that affect forex spreads, depending on the type of currency involved, economic conditions and the time of trade in a day. Forex spreads are calculated in pips, that refer to the smallest unit of the movement of price for a currency pair.
In order to better understand forex spreads, let’s consider an example. Suppose you are trading EUR/USD at 1.2090/1.2093 the forex spread is calculated as 1.2093-1.2090, which accounts to 0.0003 or 3 pips. Traders generally prefer a lower rate of forex spread as it indicates lower volatility and higher liquidity rate, especially during major forex trading sessions.
How Does Forex Spread Work?
Forex spread is one of the major aspects of trading as it represents the volatility and liquidity rate of a currency pair. Forex spread indicates the difference between the sell and buy price also known as the bid and ask price. A trader calculates forex spread by subtracting the bid price from the ask price of that particular currency. A trader might purchase a currency pair for a lower price and sell it for a higher price, depending on their trading strategy.
Naturally, all traders prefer lower forex spreads as lower forex spreads means lower trading cost for a trader. A higher forex spread is considered risky in trading as it might indicate potential risks and chances of loss. A trader should choose the most suitable type of currency pair, a suitable trading session in a day and a reliable broker in order to avoid a higher forex spread. A higher forex spread indicates that a buyer would pay more when buying and receive a lesser amount when selling the same pair.
We do understand by now what a forex spread refers to, and what it can imply to a trader. The trader subtracts the bid price from the ask price and the difference is referred to as forex spread which is measured in pips. A lower forex spread is preferred by traders as it indicates more liquidity. There are a number of factors that affect the forex spread apart from broker’s trading conditions, these might include the time of the day at which the currency is traded, the type of currency involved in trading and economic conditions prevalent in the market.
A trader should keep in mind all the conditions and factors affecting forex spread before trading, and also preferably use a broker that offers low forex spreads, as this would give them more profitable trading opportunities.