To understand the basic notion of “Forex spread” it is enough to compare the cost of the given currency in trade terminal or in any bank office. You should pay special attention to the fact that each currency has two prices actual at any time.
If we take a bank as an example we will see that it buys currency from people at one price that is smaller, and sells it at the bigger price. It means that the price of the given currency has a gap or a spread.
To better understand what Forex spread is we will look at one example. After opening trade terminal trader sees Forex broker offering two prices and understands what they are needed for. The higher currency price is called ASK and is equal to 1.1602, for example. The lower price is BID and is equal to 1.1598. The trader is offered to buy at the higher price and to sell at the lower one.
So, what is Forex spread? For example, the trader decides to buy currency as he forecast its growth. So, he buys it from the broker at 1.1602 (ASK). In some time after the currency quotes have grown the trader wants to sell it and to obtain profit. At the moment of sale the market also offers two prices: ASK – 1.1706 and BID – 1.1702. In this case the trader sells the currency bought earlier at the BID price.
Speak plainly, spread is a Forex broker’s earning. That is, there is always a certain market price which serves as a basis for the broker to offer the currency price. It is that very difference which makes up the main part of the profit of dealing centers.
Taking all the above-mentioned into account the trader should understand that different brokers offer various trading conditions. Accordingly, the size of spread can vary greatly sometimes even consuming the profit of the trading speculator. Thus, it is vitally important to pay attention to the best brokers being in the TOP ratings and to choose the best trading conditions. Special attention should be paid to the dealing centers which offer the lowest spreads.
While looking for the broker people quite often find out that it is quite difficult to choose one just on the basis of the spread size. Mainly, the reason lies in the fact that the beginning trader cannot understand some popular broker’s tricks. As a rule, every broker offers several trading accounts and multiple financial instruments. While describing trading conditions dealing centers usually stipulates the smallest Forex spread. However, this spread is applied only for the limited quantity of currency pairs at the certain account type. Besides, very obscure wordings such as “spread from 0.9 points” are often provided. These wordings do not depict the real market situation in most cases.
That is why the trader should understand not only the very notion of the Forex spread, but also specific features that show how and under which conditions the spread changes. So, the trader should look at the following factors:
1. General sentiments on the Forex market. Sometimes any important news can cause a panic on the market due to which the broker will have to protect his position and increase the spread.
2. If the broker stipulates a floating spread its size can change depending upon the time and even certain calendar days. However one should not mix it up with calendar spread which is a difference between the simultaneous sales of options with different exercise dates.
3. Spread size is greatly influenced by the liquidity of the chosen currency pair. That is why new comers are offered to work with popular currency pairs which always show big moves with vast majority of chances to gain profit. Moreover, they are characterized by small spreads that do not consume the profit itself.
4. The transaction amount plays another important role. The broker does not work for charitable causes and small transaction volume causes the growth of the spread as the dealing center has to include the expenses in the commission. However when there is the only one transaction even with big amount the spread will also be big as the broker risks a lot and tries to secure his position in any possible way.
By understanding these simple, but very important principles the beginning trader can choose a broker with more awareness of the subject that will help him obtain the best trading variant.
Forex spreads differ from each other by their formation structure and cause various consequences while trading with them.
1. Floating spread means that the broker using this type of spread changes the size of the commission if the Forex prices are changed.
2. Fixed spread is applied only at small trading accounts, mainly cent ones. Its size is not changed under any conditions as all the transactions are calculated automatically by the broker.
3. Fixed changeable spread means that under the crisis conditions occurring on the Forex market the broker can increase the spread size trying to protect his position.
One can also mention one more spread type that is a protective spread. As a rule, it is used by traders while trading via pending orders. The purpose of this spread is to protect trader’s position from the slippages that happen on Forex.
Besides, investors can use the yield spread. In fact, this spread is a difference between the profits gained with two different debt financial instruments. Understanding this spread type it is easy to forecast possible profitability and to choose more efficient financial instruments.