Home / Learn To Trade Forex / What is the Spread in Forex Trading?

What is the Spread in Forex Trading?

FX Scouts By Jeffrey Cammack Updated: November 11, 2019

Currencies are quoted with two prices called the bid and the ask price.  The bid is the highest price that the market is willing to pay for a currency pair, while the ask is the lowest price that the market is willing to sell it for.  The spread is the difference between the bid price and the ask price.

The spread is primarily how brokers make money, and a spread can be coupled with a commission on volume traded.  The spread charged is highly dependent on the business model of the broker and their access to liquidity.

Types of Spreads

what-is-a-spread

There are two different ways spreads fluctuate. The most common spread is the Fixed Spread, which means that the difference between the bid price and the ask price is kept constant. The second type of spread is the Variable Spread, which means that the difference between the bid and the ask price fluctuates following market conditions.

What does a Spread Tell You?

The spread is primarily a function of currency liquidity, and in this regard, a lower spread will tell you that the Forex pair liquidity is greater, while a higher spread will tell you that the Forex pair liquidity is low. The major currency pairs which have the biggest trading volume are usually traded with the lowest spreads while exotic currency pairs are traded with higher spreads. A wider spread will make it more challenging to profit from the trade; that’s why it’s advised to only trade lower spreads currency pairs.

Dependent on the type of the spread you’re charged, your Forex broker can either be a Dealing Desk broker or a Non-Dealing Desk Broker, so the spread also gives you more information about your Forex broker.

Spreads During News Events

Before major economic announcements or news releases, market volatility can increase considerably. These events can cause large price movements, so spreads may widen due to uncertainty and risk. Usually, during news events, market participants are pulling off their bids and offers, which means lower liquidity is available, and that causes the spread to widen.

With news trading, traders can generally predict when these news events are likely to occur, even if you can’t necessarily predict the content of the report.  Just knowing when the market is expected to move because of a news event is extremely important for gauging when the spread is likely to widen.

Spreads and Margin Calls

If we trade Forex currency pairs with variable spreads and the spread suddenly widens up, there is a risk of causing a margin call. A margin call is a process of liquidating all open positions to ensure you’re not losing more than your account balance. Since spreads widen during news events, and if you’re overleveraged, than the risks of getting a margin call increase considerably.

Conclusion

The reason we have a spread is so that there’s no arbitrage in the market; which means that there’s free money. You can’t just go out and buy a Forex pair and immediately sell it right back to the market without having any risk whatsoever. The wider the spread is, the higher the Forex volatility and the more vigilant you should be with your trading. Successful trading requires to focus on the spread management, which should be part of your risk management.

Stay updated

This form has double opt in enabled. You will need to confirm your email address before being added to the list.

Trading Forex and CFDs is not suitable for all investors and comes with a high risk of losing money rapidly due to leverage. 75-90% of retail investors lose money trading these products. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.