A spread is the difference between the purchase and sale price of a financial asset at the same time. In fact, the spread is a commission charged by a brokerage company or dealing center from its customers. The size of this commission plays an important role for all types of trading strategies. Today we will tell you how to calculate the spread on Forex.
Traditionally, spreads on the Forex currency market are not measured in monetary and percentage terms, but in points – the minimum values of price changes. For example, if the current quote of the currency pair is 1.04000 and 1.04020, the spread is equal to the difference of these prices – twenty points. In trader circles, it is customary to distinguish between the so-called “narrow” and “wide” spreads, but this classification is very conditional – different currency pairs have different measurement scales and it is impossible to objectively identify a common criterion for comparison.
The size of the spread is determined by many factors, the most important of which is the liquidity of the traded asset. For example, the most traded and, accordingly, the most liquid Forex pair is EUR/USD – this asset has the smallest spread size. The assets with the maximum size of the price difference are some majors and exotic pairs with the inclusion of currencies of developing countries of the world.
In the retail segment of the Forex currency market, there are two types of spreads – floating and fixed. The fixed spread historically appeared first – this is such a spread, the size of which does not depend on extraneous factors. A floating spread is the difference in the purchase and sale prices of an asset, the size of which depends on the level of current market volatility. Floating spread is a product of the interbank foreign exchange market. As the retail segment was streamlined, the floating spread began to take the place of the fixed one, although some brokerage companies continue to offer their customers a constant difference.
The advantages of a fixed spread are obvious – the trader always knows what commission he will pay when opening an order. He does not need to worry about jumps in volatility, there is no danger that at the moment when it is necessary to close open poses, the price will be completely different from what he sees on the monitor screen. In addition, a fixed spread is the best solution for short-term trading. Scalping, pipsing, high-frequency arbitrage are designed to produce minimal profit, and an expanding spread can destroy it in a matter of fractions of a second.
In order to see the current spread size, you need to open a trading terminal, activate the Market Watch information window and select the asset of interest to you from the list. Click on the asset symbol and in the window that opens in its left part you can see a tick chart with two curves – Ask and Bid. The difference between them is the size of the current spread. To translate the resulting value into points, simply multiply this number by ten thousand for all currency pairs except yen. For pairs involving the Japanese currency, multiply by a thousand.
As you can see, the spread is a mandatory component of the margin trading process in the financial markets. Each trader needs to understand its structure and know the main differences of its types, regardless of the level of experience and training. When choosing a brokerage company, pay attention to the principle of spread formation – if you are a fan of short-term trading, then you better opt for a broker with a fixed difference. For long-term and medium-term strategies, the spread parameter is not so important, since the size of the potential profit exceeds any commission fees of the company.