What is a Forex Spread ?
A Forex spread is the difference between the bid price and the ask price of a currency pair. Each Forex company offers different spreads on each of its currency pairs. For example if the EUR/USD pair has a spread of 1.5 pips that means the trader will be able to buy the EUR/USD pair at 1.5 pips.
There are two types of spreads; Fixed Spreads and Floating Spreads. Fixed spreads mean that the spread offered for a pair does not change no matter the price changes. Usually fixed spreads are higher but they guarantee traders that they will always be betting on the same price, and never worry about the price getting any higher.
Most Spreads however are Floating, and that means they can move either up or down based on market movements. Obviously these spreads are less predictable, but they have a chance of becoming even lower and helping the trader earn more. But their initial prices are usually lower which is why many traders prefer them.
Forex companies make their money by taking a small percentage of the spread, so every time a position is opened the company makes a small amount of the spread.
Traders are usually looking for the lowest spreads, especially new comers, or those who can’t invest big money, but a lower spread does not always offer the best option. It is important to remember that the lower the spread the lower the risk, but also the lower the profits. Higher spreads would cost more but the returns would also be more profitable.
What is Forex Zero Spread ?
A Forex spread is the difference between the bid price and ask price, and it is where companies get their commission from every position opened by a trader. Each company offers a different spread on each currency pair, and some charge extra commission per position.
Some companies offer very low spread while others offer much higher ones, and usually traders are looking for the lower spreads when trading Forex because a lower spread allows them to open bigger positions with smaller amounts of money.
A lower spread however does not always mean better trading. Trading conditions have many sides to them, including leverage, trading tools, customer service of a company and many more. Another important thing is whether commission will be charged for the spread or not. Sometimes a company will offer lower spreads but ad commission.
Zero Spreads are offered by some forex brokers, where the lowest spread is 0.0 pips. However in most cases this applies to ‘floating’ spreads, which are non-fixed spreads that can move up or down according to market movements, so the 0.0 spread can be on average at 0.5 pips.
And in some cases there may be a commission charged on the side of the 0.0 pip spread, so when a company offers a zero spread, it is important to look out for all the other factors which could make up for that zero spread.
How to calculate Forex Spread?
Retail forex trader who buys EUR 100,000 on margin. The current quote in the market is EUR 1 = USD 1.3300 / 1.3302.
The bid-ask spread in this case is 2 pips. The spread as a percentage is 0.015% (i.e. 0.0002 / 1.3302) of the traded amount of EUR 100,000.
Specifically with regard to forex spreads, take a note:
- Most forex trading at the retail level is done using a great deal of leverage, because of which spread costs as a percentage of the trader’s equity can be quite high. In the above example, assume the trader had equity of $5,000 in his or her account (which implies leverage of about 26.6:1 in this case). The $20 spread amounts to 0.4% of the trader’s margin in this instance.
- For a quick calculation of the cost of the spread as a percentage of your margin or equity, simply multiply the spread percentage by the degree of leverage. For example, if the spread in the above case was 5 pips (1.3300 / 1.3305), and the amount of leverage was 50:1, the cost of the spread as a percentage of the margin deposit is as much as 1.879% (0.0376% x 50).
- Spread costs can add up quickly in the rapid-fire world of forex trading, where traders’ holding period or investment horizon is typically much shorter than in stock trading.