What is spread in forex trading and why does it matter?
Reading time: 8 minutes
Imagine you’re walking through an international airport. You see a currency exchange kiosk with a big flashing sign that says ‘Zero Commission’. So, you decide to swap your US dollars (USD) for euros (EUR). But when you look at the board, you notice two different prices for the same currency pair. One price shows how much the kiosk will charge you to buy euros (the ask price), while the other shows how much it will pay if you sell euros back (the bid price).
The difference between these two prices is one of the ways the exchange provider makes money. In forex trading, that gap is known as the spread. It is one of the main costs of trading, and it affects every position you open. Understanding how spreads work is essential for managing costs and evaluating potential profits.
What is spread?
In forex trading, every currency pair is quoted with two prices:
- Bid price: The price at which the market is willing to buy the currency from you.
- Ask price: The price at which the market is willing to sell the currency to you.
Spread is simply the difference between these two prices.
How to calculate spread
Price changes in forex are usually measured in pips (short for ‘percentage in point’). For most pairs, a pip is the fourth decimal digit (0.0001).
To calculate the spread, subtract the bid price from the ask price. So, spread = ask price - bid price
For example, let’s say the EUR/USD is quoted at a bid price of US$1.0850 and an ask price of US$1.0852. Here, the spread is: 1.0852 - 1.0850 = 0.0002 (or 2 pips).
Factors that impact spread
Spreads are constantly changing based on market conditions. Several factors affect the price sellers are willing to accept as well as the price buyers are willing to pay.
Liquidity
This is one of the most significant factors affecting spreads. Major pairs like EUR/USD or GBP/USD tend to attract a large number of buyers and sellers. Because trading in these pairs is happening at such a large scale, the spreads are usually tight. On the other hand, exotic pairs (like those that consist of the Mexican peso - MXN or Turkish lira - TRY) tend to have much lower trading volumes, which leads to lower liquidity. As a result, brokers might charge a higher spread to cover the risk of trading them.
Volatility
When the market fluctuates, such as due to a surprise central bank announcement or geopolitical tensions, spreads tend to widen. This is because rapid price movements can increase market risk.
Time of day
The forex market is open 24/5, but liquidity varies throughout the day. When the London and New York markets overlap, liquidity is at its peak and spreads are typically tightest. They tend to widen when fewer people are trading, like during the Sydney session.
Why accounting for spread matters
Spread represents the direct, built-in cost that affects every forex position you open. So, if you ignore the spread, you aren’t accounting for all the costs that affect your trading results. In a market as fast-moving as forex, every pip counts toward your bottom line. Narrow spreads reduce transaction costs and improve potential profitability, while wide spreads act as higher fees and reflect lower liquidity.
The most immediate impact of spread is that it creates a ‘virtual loss’ the moment you click 'Buy.' If you enter a trade with a 2-pip spread, the market must move 2.1 pips in your favour before you see even one cent of profit. For long-term investors, this is a minor speed bump, but for a beginner trying their hand at day trading, these costs can add up to thousands of dollars over a year.
Spread should also be accounted for in your risk management strategy. Many traders set a stop-loss to limit potential losses. However, during high-volatility events, such as a central bank raising interest rates, spreads can widen significantly. If your stop-loss is too close to the market price, a sudden spike in the spread can trigger the position to close, even if the actual market price never reached the stop level.
Monitoring spreads can also show you whether your chosen currency pair is seeing high or low liquidity at present. Higher spreads tend to signal low liquidity, and vice versa.
Types of spreads
Not all brokers manage spreads the same way.The spread model you choose can influence your trading costs, execution experience and overall strategy, particularly if you trade frequently. Here’s a look at the different types:
Raw spreads
Raw spreads are often associated with institutional-style pricing. Raw spreads are the actual prices coming directly from big banks and liquidity providers. They can be as low as 0.0 pips on major currency pairs. However, brokers might charge you a flat commission per trade when you choose raw spreads. Raw spreads are the most popular among high-frequency traders, like scalpers, who need the tightest price to carve out small profits through the day.
Fixed spreads
As the name suggests, fixed spreads stay the same under normal market conditions. Whether the market is calm or chaotic, you know exactly what the cost will be. The benefit here is predictability. You can calculate your costs to the cent before you trade. However, the drawback is that they tend to be higher than the average floating spread. Also, during high volatility, you might experience requotes if the broker can’t fill your order at the quoted fixed price.
Floating (variable) spreads
This is the most common model. The spread fluctuates based on market conditions, such that they are usually tight during periods of high liquidity and lower volatility and wide during major news events or periods of market uncertainty.
Strategies for managing spread costs
Spread-aware trading strategies focus on reducing the impact of spreads on overall trading costs by improving timing, instrument selection and execution conditions. As a result, traders often aim to minimise spread exposure and optimise trading conditions. Here are three ways to use your knowledge of spreads as part of your trading strategy. However, remember to always practice on a demo account to see how the strategy works and fine-tune it before applying it to the live markets.
Focusing on low spreads
The simplest way to beat the spread is to avoid trading expensive forex pairs. By sticking to the majors (like the EUR/USD, USD/JPY and GBP/USD), you can access tighter spreads than when you trade minors or exotics. This is because high liquidity helps keep spreads on major pairs consistently low, reducing the cost of each trade.
Time-based trading
As mentioned earlier, spreads fluctuate throughout the day. A time-based strategy involves only executing trades during the ‘golden hours’ of high liquidity, which is usually the time when the London and New York sessions overlap. Some traders tend to avoid trading 30 minutes before and after major news releases (like the US Non-Farm Payrolls), since such announcements can lead to volatility and widen spreads.
Scalping with tight spreads
Scalpers aim to capture small price movements, often in the range of a few pips. In such strategies, spread costs play a critical role in determining profitability.
For example, if a trade targets a 3–5 pip move and the spread is 2 pips, a significant portion of the potential profit is consumed by transaction costs. This is why scalpers often prefer raw spread accounts, where lower spreads are offset by a small commission, resulting in a lower break-even threshold.
Don't let the spread be an afterthought
In forex trading, spread is more than just a number on a screen; it’s a vital figure that affects your profitability. It can be the difference between a ‘good’ entry and a ‘great’ one. By understanding how spreads are calculated, what makes them move and which pricing model fits your style, you can transform the spread from a hidden cost into a manageable part of your trading strategy. After all, successful trading isn’t just about predicting where the price will go next but also about managing the costs of getting there.
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