What is a spread in forex trading? How does spread work in forex trading?
For forex traders who have long-time experience in the forex trading journey.
Of course, they are familiar with the word spread.
But for novice traders, maybe they still don’t understand what spreads are.
Even though in the forex community forums this term is common.
Spread is the difference between the selling price (bid) and the buy value (ask) or sell quotes and buy quotes.
This spread is broker income where if we open a new position, the spread will be charged between 2 points to tens of points depending on the traded pair.
TenkoFX is a no dealing desk broker that offers services on forex, CFD and crypto, you can choose STP or ECN accounts and or crypto accounts.
No dealing desk brokers offer variable spreads because they work with leading liquidity providers and not market maker brokers, you can access the contract specifications on the company’s website page.
How does spread work in forex trading?
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Price quotes on the broker’s trading platform have two options “bid” and “ask” price.
The meaning of “bid” is the price at which you will open Sell on the base currency.
While the definition of “ask” is the price at which you will open Buy on the base currency.
You will see the difference between the “bid” price and the “ask” price on your trading platform.
And the difference from that price is called the spread.
From this difference in prices, brokers get profit from their clients when clients open new orders.
The size of the spread varies in each pair.
And also for the same pair, the spreads given can vary between one forex broker and another broker.
So you should refer to your broker to find out the amount of spread offered.
There are even brokers who say no commission.
Even though it is only a misleading expression because they take the cost to clients through the spread.
How to calculate spread in forex trading?
The value of the spread is usually measured in pips, which is the smallest unit of price change.
In most pairs, we will see prices with four decimal places behind the comma, so that for one pip it will be written as 0.0001.
We take the example of the EUR/USD pair, where most brokers set the spread on this pair at 2 pips, so the price writing will be 1.1051 / 1.1053. This quote indicates a spread of 2 pips, in a simple way to calculating spread in forex with “bid price” deducted with “ask price”
In the image below is an illustration on EUR / USD pair with a spread of 2 pips
In pairs involving Japanese Yen, there are only two decimal places behind the comma of the four-digit broker, but to be three digits behind the comma of the five-digit broker.
To calculate the amount of spread is also the same as other pairs, for example, the pair USD / JPY shows the price quote at 110.00 / 110.04 this means that the spread amount is 4 pips.
Types of spread in forex
In forex trading, it is known as fixed spread and variable or floating spread.
Some forex brokers use fixed spreads, that is, spreads that don’t change under any market conditions.
But some are using a floating spread system or also called a variable spread, where the spread varies depending on market conditions.
This image below giving an illustration of how fixed and variable spread work.
Like we have already discussed dealing desk brokers and no dealing desk, a fixed spread is usually offered by dealing desk brokers or market makers, whereas variable spreads are offered by no dealing desk brokers.
What is fixed spread in the forex?
As the name suggests this fixed spread will remain the same value, even if the market conditions are very volatile.
Or in calm conditions without movement, the value of this spread will remain the same and is not affected by price volatility.
These fixed spreads are mostly offered by dealing desk brokers, their dealing desk brokers buy large positions at liquidity providers and then offer these positions to their clients of small size.
This means the broker acts as a counterparty to their clients.
By having a dealing desk they dare to offer fixed spreads because they control the price of quotes on their platforms that can be displayed on charts.
Advantages of trading with fixed spreads
Trading using fixed spread is cheap alternative trading for traders who have low capital because the spread value does not change.
Trading using fixed spreads also makes it easier to calculate transaction costs, because the spread value does not change.
You will feel confident about your open position because you will not worry after an open order will see a wide floating loss, but you will see floating loss only amount of spread cost.
Disadvantages of trading with fixed spreads
A problem that often comes with brokers who offer fixed spreads is “requote”
This happens because the price quote only comes from one source, namely the broker (this is a dealing desk broker)
And this frequent occurrence of this requote even matches your status post on the social network Facebook or Instagram.
The time will come when the market is very volatile, and prices change so quickly because brokers offer fixed spreads they cannot widen the spread.
So when you place an order the broker will block your order and there will be a warning alert, you will be offered at a new price.
If you click OK then you will get a different price from the previous price, and if it turns out that the market conditions are still very volatile when you click OK.
But it still possible happens to requote and you will get a requote warning and offered at a new price.
For most trades requote problems are harmful because they don’t get the best price, but they are offered at a new, at a worse price.
Another problem that sometimes occurs with brokers that offer fixed spreads is about slippage.
When prices move very fast, the broker cannot consistently maintain a fixed spread.
So when you open a new order, you do not get the price listed on the trading platform, but it differs greatly from what you expect.
Slippage is similar to your first date with a handsome girl or guy you know from social networks, but after you meet him, just realize the real person in front of you looks nothing like a photo of your introduction on social networks.
What are the variable Spreads in Forex?
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Variable spread, or also called floating spread is usually offered by no dealing desk brokers
As the name implies, variable spreads are value spread always change.
Brokers that offer variable spreads the price of quote “bid and ask” prices on pairs often changing.
Because no dealing desk brokers get price quotes from several liquidity providers.
They do not specify price quotes, they forward order by the client to liquidity providers without going through the dealing desk.
This means they do not control the value of the spread so that the spread will widen or tighten based on demand and supply pairs, and price volatility that occurs in the market.
Usually spread will widen because there is high impact news that affects the rapid price movements in the market as well in other periods when volatility decreases.
The image below is an illustration for the variable spread
For example, you will buy EUR / USD pairs with a spread of 2 pips.
But you make this order when the high impact NFP news is released.
This causes price movements to become higher in volatility, and you find the spread widening by 20 pips.
Or when there is other high impact news.
For example, President Trump’s tweets give the effect of strengthening or weakening of the USD which causes very fast price movements, this can cause spreads on variable spreads to widen.
Advantages of trading with variable spreads
One advantage of trading with a broker that offers variable spreads is minimizing the possibility of requotes.
This means that at any price you open a position it will always be forwarded to the liquidity provider.
This is because variations in spreads from liquidity providers always change to market dynamics.
Using this variable spread provides price transparency from liquidity providers.
Which means you get the best price due to intense competition
Disadvantages of Trading With Variable Spreads
For traders who like scalping techniques, using a broker that offers variable spreads may not be suitable.
But if using a variable spread broker feels safer and more comfortable, then to avoid widening the spread conditions, they can choose to trade when the market is calm there is no news.
And also always use a stop loss before opening a new order, this is in anticipation of a widening spread.
Because variable spread is a bad condition when there is high impact news which causes very high market volatility.
Therefore traders who use variable spread brokers are better to always read the latest news updates as a step in anticipation.
Which are better, fixed or variable spreads?
Which is better by using fixed spread or variable spread?
This, of course, returns to the needs of each trader.
Maybe there are traders who prefer fixed spreads and some who prefer variable spreads, and everything is comfortable for them.
In general, traders who have a minimum capital, they prefer to use a fixed spread.
Because they less often open positions on a limited amount of capital.
Whereas traders who use larger capital.
Will tend to like trading with variable spreads when prices are at their peak when spreads are very tight.
And also for traders who like trading without requotes.
Choosing a broker with variable spreads will minimize the possibility of price requotes.
Requote becomes a boring condition when it will close or open a position when high volatility.
Calculated spread costs
Basically now you are starting to understand what spreads are and what types of spreads are
Then how do you calculate the spread? This is a very simple job, you only need data:
- Value per pip
- The size of the position of your order.
For example, you find on your trading platform to pair EURUSD at buy 1.35640 and sell EURUSD at 1.35626.
From the calculation of the spreads of the two quotations, the spread is 1.4 pips.
This is the broker using five digits decimal.
To calculate the total cost, you multiply by the number of lots you use.
If you use 1 mini lot or 10,000 units the value of 1 pip is $ 1 so your total cost is $ 1.40
The spread value in a pip is linear, meaning that if you increase the lot size volume.
Transaction costs will increase too.
To calculate it you need to multiply the spread value by the total lot size in your trade.
So, for example, you trade in a pair with a 1.4 pip spread and you open a position of 5 mini lots.
Then your transaction fee will be 7 $.
This spread is a transaction fee that is charged by the broker to the trader when opening a new order.
This is the trader’s first loss before gaining profit or loss.
So when you open a new position, you will see a floating loss equal to the spread value.
And if you close the position immediately, you will face a loss in the amount of the spread.
Knowing the spread costs when trading is very important.
Because this is the first loss for a trader before making a profit.
You already understand the fixed spread type and variable spread.
And will determine the broker according to the choice of spread type you want.
Both of them have advantages and disadvantages, maybe you will be familiar with the conditions of the broker of your choice and will adjust the best time for trading, with the aim of minimizing risk
Until here the discussion about spreads, and next we will discuss bucket shop brokers and how to protect from scam brokers.