In forex trading, brokers give you two prices for every currency pair: the bid price and the ask price.
- The bid price is the amount at which you can sell the base currency.
- The ask price is the amount at which you can buy the base currency.
The difference between the bid and ask prices is called the spread. This is also referred to as the bid/ask spread.
How Brokers Make Money Through the Spread
Many brokers advertise themselves as “no commission” brokers. What this really means is that they don’t charge you a separate fee for making a trade. Instead, they build the cost into the spread.
The spread acts as the broker’s profit for helping you complete trades instantly. So, when you open a trade, the spread becomes your transaction cost.
Let’s break it down: brokers make money by selling a currency to you for a higher price than they bought it, or buying it from you for a lower price than they’ll resell it. That gap is their profit—known as the spread.
Think of it like a second-hand phone shop. If they know they can resell your old iPhone for $1,000, they’ll only offer you $999 (or less) so they make a profit. That $1 difference is their “spread.”
So, when a broker says there are “zero commissions,” it can be misleading. Yes, there’s no separate fee, but you’re still paying through the spread.
How Is the Spread Measured?
Spreads are measured in pips, which is the smallest change in price a currency pair can make.
- For most currency pairs, 1 pip = 0.0001
- For pairs involving the Japanese yen (like USD/JPY), 1 pip = 0.01
Example: If EUR/USD is quoted at 1.1051/1.1053, the spread is 2 pips.
For USD/JPY, a quote like 110.00/110.04 means a spread of 4 pips.
Types of Forex Spreads
The type of spread you get depends on the broker’s business model. There are two main types:
- Fixed Spreads
- Variable (Floating) Spreads
What Are Fixed Spreads?
Fixed spreads stay the same, no matter what’s going on in the market. Whether the market is calm or highly volatile, the spread doesn’t change.
These spreads are usually offered by market maker brokers or dealing desk brokers. These brokers buy large amounts of currency from liquidity providers and sell them in smaller chunks to traders.
Because they control the prices shown on their platforms, they can keep spreads fixed.
Benefits of Trading with Fixed Spreads:
- Lower capital requirements, great for new or low-budget traders.
- Easier to calculate transaction costs because the spread is always the same.
- Makes budgeting and planning trades more predictable.
Drawbacks of Fixed Spreads:
- You may experience requotes, especially in fast-moving markets.
- A requote happens when the broker can’t give you the price you clicked on and offers a new one—often worse.
- Slippage may occur, especially during high volatility.
- This means you enter a trade expecting one price but end up getting a very different one.
- It’s like expecting to meet your online date and realizing they don’t look like their profile photo.
What Are Variable Spreads?
Variable spreads are always changing. The difference between the bid and ask prices can grow or shrink at any time, depending on the market.
These are offered by non-dealing desk brokers who get their prices from several liquidity providers. They don’t control the spreads—the market does.
Spreads usually widen during:
- Economic news releases
- Times of low liquidity (like holidays or late at night)
- Unexpected events (like political tweets or natural disasters)
Benefits of Variable Spreads:
- No requotes, since spreads adjust in real time.
- More transparent pricing, as you’re getting live prices from several providers.
- Often lower spreads during active trading hours due to market competition.
Drawbacks of Variable Spreads:
- Not ideal for scalpers or news traders, as spreads can widen suddenly and eat into profits.
- During high-impact news events, what seems like a profitable trade can quickly turn into a losing one due to a sudden jump in the spread.
Fixed vs. Variable Spreads: Which One Should You Choose?
The best choice depends on your trading style, account size, and risk tolerance.
- Fixed spreads work better for:
- New traders
- Those with smaller accounts
- Traders who prefer stable and predictable costs
- Variable spreads suit:
- Experienced traders
- Those trading during active market hours
- Traders who want faster execution and no requotes
How to Calculate Spread Costs
Now that you understand what a spread is and the different types, let’s learn how to calculate its cost.
You need two things:
- Pip value (depends on your trade size)
- Number of lots you’re trading
Example:
If EUR/USD is quoted at 1.35640/1.35626, the spread is 1.4 pips.
If you trade one mini lot (10,000 units), and the pip value is $1, then:
- Transaction cost = 1.4 pips × $1 = $1.40
If you trade 5 mini lots, your cost becomes:
- 1.4 pips × $1 × 5 = $7.00
The larger your trade size, the more you pay in spread cost. So always consider the spread when planning your trades, especially if you’re trading multiple lots.
Final Thoughts
Understanding spreads is essential for any forex trader. Whether you go for fixed or variable spreads, knowing how they work, how they’re measured, and how they affect your trading costs can help you make smarter decisions and manage your money better.
The spread might seem small, but over many trades, it adds up—so always keep it in mind when planning your trades!
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