What Is The Spread?
By: Stephanie
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What is The Spread?
Unlike stocks, options and futures, Forex trading doesn't usually involve commissions, clearing fees, exchange fees, government fees, or direct brokerage fees. Brokers are compensated for their services through something called “the spread”.
Let’s take an example of EUR/USD 1.5536. When you go to place a trade order, or even if you are just checking out the quote prices, you will often see something that looks like this:
Here you can see the actual currency pair and it's Bid and Ask prices. The difference between the bid and ask prices is called the spread. Different brokers use different values for the spread, and you generally want to stay in the 2-5 pip range or less for the spread.
Here is why...
The spread is how the broker makes money. The larger the spread, the more it cuts into your profits.
The current quote for EUR/USD is 1.5536/1.5538, which means it has a 2 pip spread. The first number is the Bid price, and the second number is the Ask price.
Securities are bought at the ASK price (the price that sellers are willing to sell for) and sold at BID price (the price that buyers are willing to buy for).
Taking our earlier example, you buy 1 lot at the ASK price of 1.5538. The market moves up 27 pips, so you decide to close your order. The quote is now EURUSD 1.5563/1.5565 (this broker has a 2 pip spread on the EUR/USD pair.)
Now you sell your position for the BID price of 1.5563, netting you 25 pips instead of 27. 2 pips (or $20) go to the broker for this trade. This might seem like a lot, but if you think about it, $20 is only 7.4% of the $270 gross profit. If the move would have been 100 pips, the gross profit would have been $1,000, less the $20 for the broker, for a net profit of $980. This equates to a trade fee of only 2%.
Regardless, it is a small price to pay, especially compared to all the fees and requirements that stocks, options and futures have. All that you need to really understand is that in order to be profitable on a trade, you must overcome the spread by at least 1 pip. But, what if you don't have $100,000 to invest? That’s okay, because you don't need that much to start. You can start with as little as a couple hundred dollars using Leverage and Margin... But thats another lesson...
I hope I've answered all your questions about what a Spread is. Next, learn the answer to the question, What Is Leverage? Keep learning and mastering Forex with us, right here at PipsAngels.com. Bye for now!
