Forex what is spread 2

Spread in Forex: Explanation & Examples.

One of the most frequently asked questions on trading forums is “What is spread in forex?” Let's try to find out.

In modern life, we have to pay for goods and services including those provided in the financial market. The most popular and demanded service in trading is brokering. A brokerage company provides access to the international financial market so that users can make transactions. Brokers charge a commission for their work and it is called the spread.

Spread Definition.

As I have already mentioned, we can define spread as a commission charged by the broker for conducting transactions in the stock exchange. When you make a trade on a stock exchange you don’t perform it yourself, you only place an order, your wish to buy or sell an asset. You pay part of the price of the transaction to the broker for the brokerage service in the stock exchange. What is Spread in Forex?

In simple terms, the spread meaning is a fee charged for conducting transactions. In terms of stock trading, the spread is the difference between the buy and the sell price of an asset.

Now, let us find out what a buy price and a sell price is, and how to measure the difference between them - the spread.

When we exchange currencies in a bank or using an exchanger, we see 2 quotes. There’s the buying price, at which the bank buys your currency, and there’s the selling price, at which the bank sells you currency. If we compare these 2 prices, we’ll see that the former is always lower than the latter. This is what is called the spread, or the difference between the buying price and the selling price. The value of this commission is regulated by the financial organization that provides exchange services.

You can also see such notions as BID and ASK in various exchanges. They mean the buying and selling prices and are defined as demand and supply in the advanced market analysis.

BID is the price at which you can sell the base currency in the pair.

ASK is the price, at which you can buy the base currency.

I suppose you know what a base currency is. However, if you want to revise some information, you can read about trading currency pairs here.

Spread Trading: What is this?

To explain this concept, I should mention that the spread in Forex trading often means the commission charged by the broker for conducting a buy or a sell trade for you. In global financial trading, the spread is defined as the difference between the buying and the selling prices of the same asset.

If we mean the difference between the buying and selling prices for the spread, it looks like this:

If we understand spread as a real difference in the prices for an asset or assets, it looks like this:

In the chart below, two assets that have their own quotes but present one asset are compared. These are two popular oil benchmarks, UKBrent and WTI, namely their CFDs. Although it’s basically the same black stuff, it has different prices. Historically, the BRENT crude oil has been more expensive than North American WTI, but the difference is very small and averages in the $3-$5 range. However, history knows many cases when the usual range has changed. It even happened that WTI cost more than BRENT. So, the ratio of the prices of these assets is called the spread position. We can also come across the concepts of correlation or correlation factor.

Spread trading or spread position is a method of trading that involves making profits from the changes in the difference between assets’ prices.

How do traders make profits from spread? If you look at the above figure, you will see that sometimes spread narrows and sometimes widens. So, the primary goal for investors is to use the spread itself as a way to generate profit when the spread widens or narrows.

Spreads are either "bought" or "sold" depending on whether the trade will profit from the widening or narrowing of the spread.

Narrowing spread position.

To make profits from a narrowing spread, you need to watch the periods when the difference in the quotes of two assets is greater than the average value.

In general, the strategy of making money on spreads is one of the longest, as it requires preparation and works out more often in long-term timeframes. In my memory, there were positions, the implementation of which took about a year. This strategy is the most conservative, as there is almost no risk. Therefore, it is usually used by large financial institutions, such as pension and insurance funds, and simply by large investors.

Let us analyse the position. First, we need to study how two assets have been moving relative to each other over a historical period. An ideal option would be to overlap two charts, but not all trading platforms provide such a possibility.

After overlapping the charts, we need to determine the average price difference for these assets. In the case of oil charts, as I mentioned, the average price difference is $3-$5. So, we should look for moments when this range is wider than $5.

In the above chart, I marked the most noticeable spread changes on the left. The difference in prices reached 10 USD. The widening of the spread up to $10 is a deviation from a median value, so it makes sense to bet on the narrowing spread, expecting that the difference will tend to the common range.

Ideally, the position is formed on the expectation that a more expensive asset will depreciate and the cheaper one will appreciate so that the difference in values will narrow. But such a situation is a rare case. Most commonly, two assets are moving in the same direction and the cheaper asset rises in price faster, thus narrowing the spread.

To avoid risks, one should open a counter position. It means we sell the more expensive oil and buy the cheaper one. For example, there is a situation in the chart when BRENT is $84.65 and WTI is $74.01. The spread is more than $10, and we bet on the spread narrowing, we sell BRENT and buy WTI. After a while, we see that oil starts depreciating, the BRENT sell trade is winning and the WTI buy trade is losing. The strategy would seem to fail. However, sometime later, BRENT is down to $50.21 and the WTI hits $46.78. So, the BRENT sell trade has yielded $34.44 of profit and the WTI purchase caused a loss of 27.23. The total position has yielded a profit of 7.21 USD.

The profit could seem insignificant. But you need to take into account a lot of factors. First, the position is almost risk-free. Second, this is an example for one lot, so it is convenient to calculate. Now, imagine that financial institutions open such positions. They make huge profits with virtually no risk. By the way, this position is one of the ways that banks earn by using depositors' money.

Widening spread position.

This position is opened while betting on the widening of the spread. You need to spot the moments when the difference in the asset values is the tightest and open a position expecting the spread to widen.

Let us look at the right part of the chart above. There is a situation when the prices for BRENT and the WTI are almost equal. There is an opportunity to make a profit from the spread widening. Here, we shall sell the cheaper asset and buy the more expensive one. Supposing, BRENT is $77.34 and the WTI is $ 34.23. After a while, both benchmarks grow in value and the BRENT purchase generates a profit of $34.23 and the WTI sale yields a loss of $ 30.12. So, the total position has made a profit of 4.11 US dollars.

As you see, the position bears almost no risk. The only risk is time. Above, I wrote that, most commonly, the BRENT is more expensive than the WTI. In the opposite case, the position will be losing. Nonetheless, such a case (WTI price is higher than BRENT) is the maximum and it can’t be lasting for a long time. In this case, you just hold the position on.

It should be noted that you can trade spreads using only closely correlated assets. For example, they can be the assets from the same sector, such as stocks of Apple and Microsoft, or EUR/USD or GBP/USD in the case of currency pairs.

You should not trade spread using assets from different sectors. The convergence in prices doesn’t mean the assets will be moving in the same direction.

Spread Examples.

Forex spread varies based on several factors.

In the above chart, in addition to the BID and ASK columns, there is the third one that shows the spread size for each trading asset. You see, spreads are quite narrow for some instruments, about 20-40 pips. For other assets, the spread size could reach 200 or 300 pips. There are several factors affecting the spread width.

First of all, the spread is affected by the liquidity of the trading instrument.

In simple terms, liquidity is the popularity of a trading instrument. The more trades conducted with an asset, the more liquid it is. This is a key parameter to calculate the spread size. High liquidity always correlates to a tight spread. And vice versa, low liquidity corresponds to a wide spread. You can see from the above table that the popular currency pairs are always traded at a narrow spread. This is the law of stock trading.

The second important parameter is volatility.

Volatility also greatly affects the size of the spread. When volatility increases, the number of price fluctuations increases, which means that the spread will widen. When volatility declines and price changes occur less often, the spread will narrow. Thus, the spread in the foreign exchange market is an indicator of volatility. Everyone knows examples when, at the time of publication of important fundamental news, volatility increased sharply, and the spread also increased.

For example, the geopolitical tensions and the economic confrontation between the USA and Russia resulted in a surge in financial markets’ volatility. The highest volatility was featured by the USD RUB currency pair. In standard situations, the spread of this currency pair doesn’t exceed 4000-5000 pips, but when the volatility surged, the spread reached 10000-11000 pips. And in some banks, the difference between offer and demand prices reached 110.0000-125.0000.

And one more factor is the interest of the broker.

Another part of the spread is the interest of the intermediary, that is, a broker or dealer. The intermediary sets the broker spread, but without going beyond. Each broker offers its own spread, but in the end, they will be about the same, because the share of the broker in the spread is not so high. Unpopular brokers set a higher spread, while popular ones, on the contrary, try to reduce it as much as possible in order to attract new customers.

How to Calculate Spread: Bid / Ask Spread Formula.

There is no great need to calculate the spread in points since it is almost always indicated in your terminal or mobile application. And here's how to convert this spread in points into dollars or euros.

The picture above is a screenshot from the mobile application of my LiteFinance broker. There are two prices in the transaction window, the buying price and the selling price. As we have already found out, these are Bid and Ask prices. This is the chart of the EUR/USD currency pair, and at the time of the screen, the BID price was 1.10558 and the ASK price was 1.10554.

The difference between these prices is a bid/ask spread, 1.10558 - 1.10554 = 0.00004 or 0.4 pips.

Now we need to convert the pip spread into money. I use the account currency, US dollars, so we will need to convert the pips to dollars. I think you are familiar with the concept of the transaction volume and know what the word “lot” means. To define the bid/ask spread value in money, you need to know the transaction volume or the lot size. In my example, I decided to enter a trade with a volume of 1 lot. For a volume of 1 lot, the formula for calculating spread will look like this: 1.10558 - 1.10554 * 10000. In my case, it will be equal to 0.4 USD or 40 cents.

If you want to calculate the spread cost for a different trade volume, you need to change the number of currency units. For example, for 0.1 lots you need to multiply by 1000, and for 2 lots – by 20000.

Of course, you can calculate the spread manually, but trading has advanced quite far and every self-respecting broker has long been providing the service of a trader's calculator, which will calculate the spread and other transaction parameters for you in real-time.

Going back to the spread concept, I want to stress that the buy spread and sell spread are a bit different. When you buy you pay the spread when you enter a trade and when you sell you pay the spread when you exit the trade.

How to Read Spreads.

Well, now you know how to calculate spread. Let me explain how to quickly learn the spread in a trading terminal and not to waste time on manual сalculation.

I will start with the MetaTrader 4 trading terminal.

When you want to enter a trade in the Metatrader terminal, you need to set parameters for the future transaction in the trade window. In the same window, you see the selling price and the buying price. If you compare these two prices in the above example, you will see that the difference between the values is just two pips, 1.11229 – 1.11227 = 0.00002. It means that the spread at the time of entering a trade is less than a point, 0.2. This is a very narrow spread, which is, by the way, normal for this broker.

Now, let us study how you can learn the spread in the LiteFinance client account.

In the trade execution window, click on the “Info on the instrument” tab. This tab displays the buying and selling prices, and the spread value in a separate field. In this example, the spread is even tighter, 1 pip.

How do Spreads Work.

Let us find out how to trade spreads. Look at the chart below.

Supposing, we want to enter a EURUSD buy trade. The price of the currency pair is 1.11617 and 1.11616. The difference of 1 pip is the difference between buying and selling prices. As we want to buy, someone should sell. The seller is in the foreign exchange, and its selling price is 1.11617. At this price, the trade will be entered, although the last price in the chart will be 1.11616. This is because we pay the price appointed by the seller.

After a while, the price rises and we decide to exit the trade. So, we are going to sell the asset we bought earlier. The buyer sets the price of 1.11621, although the foreign exchange price is 1.11622. Thus, summing up all these prices, we see that the price covered the distance between 1.11616 and 1.11622, that is 6 pips. But we made a profit from the distance between 1.11617 and 1.11621, that is 4 pips. Two missing pips are the spread.

As I said, the spread is the difference between the buy price and the sell price. The above chart shows that these prices are currently the same, and the spread is 0. This is possible only on the ECN accounts. If you are lucky to enter a trade at such a moment you will enter a zero spread forex trade. But do not forget that you will have to pay a commission for the transaction execution.

For major trading instruments, the spread is always expressed in pips. To find out the cost of the spread in the currency of your transaction, you need to convert the pips into money. It is easy if you know the pip value.

In the above chart, the spread is one pip. To calculate the cost of the spread we also need the trade volume. As an example, I will use the standard trade volume of one lot. With a standard volume on the GBPUSD currency pair, the cost of one pip is 1 USD. And since our spread is 1 pip, it will cost 1 USD.

Thus, entering a trade with the contract size of one lot, we will pay the spread of 1 USD, which will be charged at the moment of opening the position. It means that at the moment of opening the trade, we will immediately lose 1 USD, the amount of the spread. So, we should earn at least the amount of spread to break even.

Forex Spreads Types.

Writing about the forex spread, I should note that there are two main types, fixed spreads and floating/variable spreads.

It is the spread whose value doesn’t depend on market factors and always remains the same. Fixed spreads are normally determined by a dealing company for micro- and mini-accounts that are served automatically.

It is the spread whose size is changing, depending on the market situation. The variable spreads are close to the conditions of the real interbank market. However, a floating spread weakens the performance of some trading strategies and makes strategy testing much more difficult.

Fixed Spread.

The major feature of fixed spreads is that their value doesn’t depend on market factors and always remains the same. It’s normally determined by a broker or, to be more exact, a dealer. This type of spread was very popular at the beginning of Forex development but it’s rarely provided nowadays. A fixed spread is determined by the broker. In most cases, a fixed spread is a favourable factor for a trader, but its value is usually higher than a raw market spread. You wouldn’t like working with such spreads. However, this type of spread remains popular with the champions of trading robots and scalping strategies because the algorithms of trading robots don’t need to be adjusted to it.

There are rather few forex brokers offering a fixed spread. The floating spread has become so popular that it has almost completely replaced the fixed spread.

Advantages of Trading with Fixed Spread.

There are hardly any advantages in trading with a fixed spread. That is why this type of spread can entirely disappear.

No slippage. The slippages are often talked about and most beginner traders are really afraid of a slippage. In fact, this is a market feature that can be avoided on fixed spread accounts. In other words, the broker will always execute your contract in full, which will avert price slippage. The spread doesn’t widen at times of high volatility and low liquidity. I suppose everyone has witnessed a situation when the spread for a trading instrument sharply widened due to an important news release in the economic calendar. This is the biggest flaw of the floating spread. But the fixed spreads are not affected by anything, as a broker has set a fixed range for the spread. You always know the spread size. Traders often used automated systems, robots, and scripts, in the forex market. These systems are based on algorithms, and these algorithms are easy to build when you know the spread in advance. You can always take it into account when setting up order triggering and in the final result. In the case of a floating spread, it is very difficult to account for it and, as a rule, it isn’t considered, appearing at the end as a surprise.

Disadvantages of Trading with Fixed Spreads.

There are three major problems with fixed spreads.

It's hard to find a broker. In the modern forex market, where the leading roles have taken over ECN accounts with NDD order execution technology, that is, without the participation of a broker, it is very difficult to find a broker providing accounts with fixed spreads. Fixed spreads can usually be applied to cent accounts, which are less and less popular. The fixed spreads are usually rather big. If the broker provides fixed spreads, it must take into account the volatility, its own profit, and the profit of the exchange. Such a broker doesn’t profit from commissions, it earns on the spread, and it sets a high spread. For example, I entered a EURUSD trade with a fixed spread of 20 pips. To compare, the current floating spread for this currency pair is about 0.3 pips. The choice is obvious. Requotes on the Instant Execution account types. There are several types of trading order execution modes. One of the most popular is the Instant Execution mode. If you apply the Instant Execution mode and the spread is fixed, you cannot avoid requotes. Besides, it will be a big problem to enter a trade if the instrument’s volatility is high. For scalpers, this is even more dangerous than slippage, because a scalper can destroy the entire system due to one failed order.

Floating / Variable Spreads.

Floating spread is the most common type of spread nowadays. It is popular because it is profitable for all parties taking part in the transaction. Brokers and dealers can regulate and adjust it fast to changing market conditions, which allows solving 2 problems at a time: provide clients with higher-quality services and earn at the moments when the spread increases.

This spread fluctuates in a certain range based on changing market conditions. As a rule, variable spreads don’t exceed 4-5 points in the most liquid trading tools under normal market conditions, but the spread may widen sharply, reaching 50-60 points, during a sharp increase in volatility. That’s why variable spreads aren’t popular with traders who use robots and advisers because automatic strategies cannot consider changes in the value of variable spreads fast. This type of spread is favourable to manual trading.

The above chart displays variable spreads for major currency pairs. As you see, a floating spread seldom exceeds even 1 pip and in most cases, it is from 0.2 to 0.6 pips.

The above screenshot displays the spread in the trading terminal window. At the time of the snapshot, the spread between the buy and sell prices is only 0.3 pips, which is a fairly common situation for this currency pair. Trading with such a low spread is very beneficial for short-term trades, where the spread is one of the main cost items.

Advantages of Trading with Floating / Variable Spread.

Trading with the floating spread has more advantages than trading the fixed spreads.

Narrow spreads during most of trading session. As we know trading hours in forex are provided by four large exchanges. And since most of the time falls on the work of the European and American trading sessions, variable spreads at this time will be minimal and can widen only in moments of serious shocks, which do not happen so often. No requotes. I wrote about requotes as a drawback of fixed spreads. Well, in trading with variable spreads everything is vice versa, your trade will be executed in any case. The only risk here is slippage. There could be zero spread. Sometimes, when the market situation is calm and still, nothing special or extraordinary happens, you can catch a moment when there is no spread at all. I have come across such a situation in trading major currency pairs several times. The broker is entirely excluded from the trading process. Transactions are executed using the No Dealing Desk technology, which completely excludes the broker from the processes of determining spreads, quotes, and other things. Thus, traders can be sure that they deal with real market participants and have access to real exchanges.

Disadvantages of Trading with Floating / Variable Spread.

Unfortunately, trading floating spread also has some drawbacks.

There could be slippages. This is perhaps the biggest flaw of the variable spread. At times of increased volatility, your trade will be executed, but the opening price of the trade may differ from the one at which you planned it. This happens when the market price changes so quickly that it sometimes goes right through the orders set in the order book. Widening spreads in case of low liquidity. During periods when there is no trading activity in the market, for example, during the Asian trading session, spreads widen to a significant size. This also happens before the market trading closes for the weekend. Sometimes the spreads widen so much that they become larger than the fixed ones. You can’t know the exact spread size. This circumstance matters for traders using robots and scripts. If your trading robot is supposed to enter a lot of trades in a short period, a floating spread could be a reason for a loss in a series of trades.

Fixed Spread vs. Variable Spread: Which one is better?

After describing the disadvantages and advantages of both types of spread, I decided to sum up the most important ones in the table below to determine which of them is the best.

As you can see in the table, the floating spread has more key advantages. This is quite logical, since variable spreads are a necessary condition to make sure that you are trading in the exchange, and the counterparties are real market participants, not the broker itself.

When trading with a floating spread, you can always find a moment for your trade when you can pay less. The only cost for you will be the commission, which will almost always be lower than the fixed spreads. With popular and large brokers, floating or variable spreads are always very close to the raw market ones. As for me, I have long ago chosen to trade with variable spreads. Moreover, my broker LiteFinance provides a spread as close to raw as possible and in recent years I have not taken it into account at all in my strategy, since it is very small.

What Spreads depend on.

As I’ve already mentioned, the spread is a commission. If so, it needs to consider the interests of all participants in an exchange operation - a trade. As a rule, the spread forms as the stock exchange’s interest combined with the broker’s interest. The formula looks as following:

Spread = stock exchange’s (bank’s) spread + broker’s spread.

The bank provides you with access to exchange operations and charges you a fee. As for the broker, it is an intermediary in exchange operations that passes your order to the stock exchange and therefore charges a commission for its participation in the process too. As the broker’s participation is more considerable, the broker’s spread size is larger than the stock exchange’s one. Because the stock exchange is a coalition of banks in its essence, we may say that the stock exchange’s spread is charged by the bank that provides quotes to your broker. The spread charged by the stock exchange is called “raw”, i.e. it’s a spread without mark-ups or broker spread added to it. There’s currently an opportunity to trade on the stock exchange with raw spreads. It became possible after ECN trading accounts were created. ECN - Electronic Communication Network.

It’s a dedicated communication network for executing trading operations that doesn’t include an intermediary broker’s interest. It provides raw spreads. This is what is called “zero spread Forex”. Actually, trading with no spreads is practically impossible, but this type of account provides for much tighter spreads. As long as the access to such trades is delivered by a broker, its interest is considered as well. But this interest isn’t paid as a part of the spread now; it’s implemented in the form of the broker’s commission. In this case, the commission will be fixed and will only depend on the volume of the trader’s operation. Also, there’s another type of relationship - CLASSIC trading accounts.

These accounts appeared much earlier than ECN. Their feature is that they include both the stock exchange’s and the broker’s spread and the spread will therefore be larger than a raw spread. However, these accounts don’t have mark-ups, so they are more advantageous than accounts with fixed spreads. Also, these accounts don’t charge a commission.

It should be understood that there is no forex with zero spreads. The exchange always takes its commission. If the broker has a zero spread, then you only have to guess as to how it makes money.

When it comes to the value of variable spreads, there are several important factors that influence it at a given time.

Liquidity of a trading instrument - the ability of goods to be sold or bought fast. On the stock exchange, all the trading instruments are divided into groups based on a number of factors, and liquidity is one of them. Liquidity means popularity. The more popular a trading tool is the higher its liquidity. It’s the main market parameter that impacts the value of spreads. The more liquid a trading tool is, the tighter its spread is. The less popular a tool is, the larger the spread is. For example, the current spread of EURUSD is 1 point. And the spread of the EURHKD pair is 187 points. This is the basic formula, but there may be some adjustments that change the dependence under certain circumstances. The volatility of a trading instrument - the number of price fluctuations per unit of time. The number of price fluctuations is measured in ticks. The more ticks per time unit, the higher volatility. Of course, an increase in volatility raises the price in points. There’s a direct relation between a spread value and volatility. The higher volatility is, the larger the spread will be during volatility leaps, and vice versa. Again, these are basic characteristics and they may change. As long as volatility’s nature is changeable, the spread will be increasing spasmodically too. For example, volatility may increase at breakneck speed when fundamental news is published and spreads rise too, and then volatility drops shortly afterward and spreads drop as well. That’s why variable spreads aren’t popular with the traders that use automatic trading systems. When the spread soars, ad hoc orders may trigger, which may crush the whole trading system afterward. Trading hours - Spread values depend on the part of the day. When a trading instrument is being traded during its main trading session, the spread will be lower than when the main trading session is closed. We can see that at night, when, for example, the European trading session is closed and the major currency pairs are quoted during the Asian session. The value of spreads is also affected by clearing - the settlement process. It happens at 24:00, broker time, and when the stock exchange closes for weekends and holidays. Spreads normally increase at those moments. Broker’s interest - the main part of spreads. This value is determined by brokers themselves based on their own understanding of the market situation. Different brokers provide different spreads. Everyone wants to make profits, but the most popular brokers are those that can find the balance between their personal interests and the client’s interest. This is one of the reasons why ECN accounts were created. Less popular brokers set higher spreads while more popular brokers try cutting them as much as possible.

How to earn from Spreads.

Now let’s talk about such a popular thing as a fx spread reimbursement. It sounds quite promising, but these are just big words actually. In fact, you can profit from spreads only if you are a broker or a broker’s partner. What an ordinary trader may claim is partial reimbursement.

There exist a lot of spread rebate services. Traders may have a part of the spread paid back. There are several options. Since there are two basic types of accounts, there are two types of a spread rebate - spread rebates in CLASSIC accounts and commission rebates in ECN accounts. To become a participant in a rebate system, you need to register on the site of the service which cooperates with your broker or to trade with a broker which provides a similar interior system. Every broker sets its own rules for a spread rebate.

These rules are quite numerous and they are mainly aimed at counteracting fraudulent schemes. These rules practically exclude micro scalping as almost every broker sets a minimum amount of points between the closing and the opening prices.

By and large, this service will be convenient only to those traders who use a medium-term trading strategy which implies 10-20 trades in a calendar month. They can be popular with scalpers but not all of their trades are subject to rebates due to strict limitations. Such services don’t fit well into long-term strategies either because the spread size is no longer important when the trade is at least 1000 points worth. Personally, I used those services at the very beginning of my trading career just for understanding what they are like. Now I don’t care about spreads at all because my long-term trading strategy yields me 3,000-5,000 points on average. With such profits, it doesn’t really matter how much spread I will pay - 1 point or 10 points.

Large spreads or a broker charging commissions: Which account to choose?

So, we’ve found out that there are two basic account types - with the stock exchange’s spread and with the broker’s spread. I often see chats and forums where people look for and compare forex brokers with low spreads. Is there any correlation between the quality of services and spread values?

The answers seem to be obvious as everyone wants to get the lowest possible Forex spreads, but it’s not all as easy as it sounds. First, let’s answer the main question: how do brokers and dealers earn?

Commissions - They are the main item of any broker’s income. Big brokers’ clientele is so large that they can afford to cut their own commissions to the lowest values. Every client pays a commission per trade, for example, 1 USD. If there are 10,000 clients, the broker will earn a lump commission of 10,000 USD. And how many trades does a client make in a day? So, the broker’s main income is made up of commissions or spreads. However, the amount of commissions can’t be endlessly reduced because there’s a breakeven point in every business. Besides profits, big brokers have some expenses too. Remember the main thing: no broker can afford to free its clients from commissions. Otherwise, they will make losses and go bankrupt soon. Big and reliable brokers can afford to cut spreads to a reasonable extent. And if they tell you they don’t charge commissions and provide raw spreads, they are frauds that earn from blowing up client accounts. Customer acquisition activities and customer loyalty. This item of the broker’s income is actually the “fuel” of the first one. If there are many clients, there are many trades. And if there are many trades, the broker will have its commission. All is so easy. Brokerage companies’ activity area isn’t very large and there are many companies. So, there’s a constant fight for new clients. All that we, traders, need is good trading conditions that satisfy us. Of course, we all don’t want to pay account deposit fees, spreads, swaps, and any other commissions, but that’s impossible. So, we look for brokers that charge the lowest fees. Brokers understand that too. They constantly cut commissions, offer us individual trading conditions, etc. Don’t go too far when choosing a broker with the lowest commissions. No one will work at a loss. If a broker doesn’t charge any commissions, it means it charges something else that we even don’t guess. I’d rather choose transparency. Client’s loss. I’ve heard this opinion from different people so many times, even when those people had to do nothing with the markets. It is partly true, but only partly. The process itself looks like the following: we make a trade on the stock exchange, paying a part of our own money as a deposit. Next, the broker accepts and executes the trade, transferring it to the stock exchange. If the trade is transferred to the stock exchange, the counterparty in the trade will be the stock exchange, or to be more precise, the bank. In financial terms, the counterparty is an opposite party in a financial transaction that has an obligation to execute the transaction. To have an obligation means to assume responsibility at the closure of the transaction. In other words: when we earn, our counterparty pays us our profit; when we lose, our counterparty earns. When the trade is transferred to the market, the broker is no longer a participant in it. The broker only earns its commission. As a matter of fact, that’s what most brokers do. But it may be that your counterparty is your broker. And it’s your broker that will pay you your profits out of its own pocket. If you lose, your loss goes to your broker. Of course, no one will want to pay their own money voluntarily. Stock exchanges have a lot of mechanisms for this case, market makers being the main of them, but brokers don’t have such mechanisms and can’t do anything in this situation. They can either pay the client his/her profits according to market rules or pay nothing, which will be a fraud. So, big brokers often act as counterparties in their clients’ trades but they always pay what is due. These brokers’ clients don’t have to care who their counterparty is because the quotes and the conditions are the same. But beginner brokers can’t earn enough from commissions just because they haven’t acquired many clients yet - people tend to trust those who have proved to be reliable. Then new brokers may resort to various tricks. For example, they offer zero-spread trading to attract clients. But you need to understand that such conditions will bring losses to the broker. That’s why these brokers often act as counterparties in their clients’ trades to be able to earn when the client loses. It’s normal practice, but there may be a problem. If the client makes profits, such a broker will hardly pay it. Not because it’s a fraud. Just because it doesn’t have money as it charges no commissions. So, don’t run after rosy promises. Remember: there’s no such thing as a free lunch.

Forex pairs with lowest spreads (forex zero spread)

The tightest variable spreads are available for ECN accounts with market execution. According to statistics, there is a ranking of TOP currency pairs with the lowest variable spreads:

EUR/USD — average size ranges from 1 to 5 pips, or 0.1 — 0.5 points.

EUR/GBP - average size ranges from 2 to 8 pips, or 0.2 — 0.8 points.

GBP/USD - average size ranges from 2 to 8 pips, or 0.2 — 0.8 points.

USD/CHF - average size ranges from 2 to 9 pips, or 0.2 — 0.9 points.

USD/CAD - average size ranges from 4 to 10 pips, or 0.4 — 1.0 points.

EUR/JPY - average size ranges from 3 to 11 pips, or 0.3 — 1.1 points.

AUD/USD - average size ranges from 4 to 12 pips, or 0.4 — 1.2 points.

Above is the average, calm-market statistics specified.

You can see variable spreads in real-time on the online platform. Pip spread is indicated there in pips for 5-digit quotes (points are the value of the fifth decimal place). If the spread is specified in the 4-digit quotes form, then its value usually looks like this: 0.3 - which means that the spread is 3 pips. Immediately after the opening of trade, the current profit column displays a loss equal to the spread value. If the spread is 2 pips, then in order to go to zero, the price of the selected trading instrument should make 2 pips in the direction you will make a profit in, and further movement will be the income of the trader. An honest broker working with ECN technologies has the main source of income in spread or commission.

The value of a floating market spread in the Forex market changes every other second and depends on several factors:

1. Liquidity of the currency pair.

The higher liquidity a currency pair has, the lower the maximum spread value for it will be. For major currency pairs, the largest spread value rarely exceeds 10 pips, and for exotic pairs, it may reach hundreds of pips. For example, for the EURMXN pair, a spread of 500 pips is a regular one. Also, each of the instruments has low liquidity periods in which the average value of the spread will be higher. As a rule, it is nighttime.

2. Economic news.

Political or economic events affect not only the value of instruments but also the spread. As a rule, in anticipation of economic news, the spread for the corresponding pair may be much higher. For example, during moments of particularly heated discussion of the Brexit issue, the spread for currency pairs with the British pound increased several times.

3. Actions of brokers.

Brokers set the spread at their discretion. There are several factors contributing to a broker's pricing. What kind of raw market spread does a liquidity provider offer? Did a broker choose to increase the spread or add a fixed commission for each lot traded to receive additional income? The main income of an honest broker is a zero spread or commission, while there are some brokers that work primarily to increase the difference between profit and loss of a client - these brokers may provide fixed spreads to lure clients and make them lose their deposits. Although they present themselves as zero-spread brokers, it is the opposite, in fact.

Forex Spread Trading FAQ.

What is a Good Forex spread?

A good forex spread is something that every trader defines themselves. But in the trading environment, it is customary to call the minimum difference in the purchase and sale prices for an asset a good spread. If your spread is close to the raw market spread, this will be considered a good spread or the spread will be considered normal.

Are institutional forex spreads worse than retail?

Of course not. Institutional trading involves forex trading of large financial institutions whose transaction volumes are so large that they need constant access to super-liquidity. This liquidity comes at the cost of large spreads. So the retail spread is much lower than the institutional one.

How do I compare a forex spread for two brokers?

If the brokers, whose spreads you want to compare, present themselves as ECN brokers and their spreads are almost the same, then there is almost no point in сomparison. But if you still decide, then the easiest way is to search the Internet for special sites that provide a comparative table of spreads offered by various brokers. If you don’t trust such sites, you can open demo accounts with comparable brokers. On a demo account, the broker provides spreads similar to real ones, so you can compare their spreads online.

How can some forex brokers offer spreads of zero?

If the broker provides a spread close to zero, it should earn on the commission. A modern broker has only two ways to make money - spread or commission. If the broker is connected to the ECN system, it provides a raw market spread, which at some points can be equal to 0, but the broker must charge you a commission. If not, then the broker is deceiving you.

Why do brokers have such wide spreads Forex exotics?

Exotic currency pairs are not as popular as major ones. As both parties are responsible for a transaction, less popular currency pairs carry more costs and more risk for the participants in the trading process, and therefore require a higher premium. By expanding the spread on such pairs, market makers simply insure themselves against insufficient liquidity.

How do forex brokers use the Spread to make money on your trades?

This is a completely natural process. Brokers are financial intermediaries, not charities. And for the fact that they accompany your transaction, bringing it to the exchange, they receive their fee, called the spread. The more trades you make and the more money you invest in those trades, the more the broker earns. This is a mutual process. If you make money, the broker also earns. And if you lose your account due to wrong actions, the broker loses earnings. So, it is not beneficial for a broker to cause the client’s losses.

What is the best charting software for spread trading?

If we are talking about spread trading in long-term time frames, you can employ any timeframe, as there is no need to monitor your trade every five minutes. The trade won’t be executed soon, so you can monitor your position on standard trading platforms such as MetaTrader 4/5 or TradingView. However, TradingView offers a big advantage – you can overlay one chart on another, which is impossible in MT4 and MT5, and therefore Forex spread trading is more convenient on this platform.

What are the best tactics for spread trading?

Traders sometimes trade scalping intraday, i.e. they use scalping strategies. Scalping means making profits from numerous trades executed in a short time. It takes a lot of energy and by the end of the day, you may feel mentally tired. I believe that trading should not burden you. Spread trading Forex should bring pleasure, both from the process and from the result. Therefore, medium- and long-term strategies are less stressful, you have more time to analyse the price chart before making a trading decision. So, I believe trading in a global timeframe is more comfortable than in a tick chart.

What is spread in trading?

A Bid/Ask spread is the difference between the BID and ASK prices in the Forex market. Also, the spread is the difference between the buy and sell prices of the same asset. In economic terms, the spread is the difference between the demand and supply of a financial asset. In simple terms, spread in trading is a fee charged by the broker for executing a trade.

Price chart of EURUSD in real time mode.

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.