Spreads

What is a Spread?
A spread is the difference between the bid and ask (buy and sell) price of a security or asset. For instance, with the trading of forex, the spread is the difference in the buy and sell price of a currency. For example, when trading the EUR/USD, the difference between the bid and ask price might only be 0.0004 EUR. This may seem small, but with a trade of 1 million EUR having a 0.0004 spread, the spread equals out to be 400 EUR. There are numerous ways to calculating spread, but this example here is quite basic and simple just to get an understanding.

Fixed Spread
A fixed spread kind of explains itself, the spread does not change according to market conditions, it remains predetermined and set as the same rate for every trade. Traders are guaranteed that the spread will not change, thus not needing to worry about this and focus on other aspects of trading. Fixed spreads are set by the broker and are generally used for accounts that are automatically traded. Fixed spreads can be helpful to traders for the fact that they know how much the market needs to move in order for them to make a profit.

Variable Spread
A variable spread, often called a “floating spread”, is quite the opposite from a fixed spread in the sense that it can change due to market conditions. During inactive markets the spread can rise quite significantly, but during high activity market hours, the spread might be very small, it can even be smaller than fixed spreads. Whatever the spread turns out to be, it will be the best price that the broker could find at any given moment. So, in times of high liquidity, the chances of a smaller spread are much greater.

Fixed & Variable Spreads
This type of spread is a sort of combination between fixed and variable. How it works is, a certain part of the spread is predetermined, while another part is determined by the dealer in regard to market conditions. This type of spread is quite favorable to many traders as it minimizes the risk of a very large spread, and allows the ability to benefit from very low spreads. This type of spread might be best for a beginner trader, who is trying to feel out the markets and how they react, without taking huge hits from large spreads.

What Influences Spread?
Several factors influence the size of a spread in forex trading. The biggest factor is currency liquidity. Popular currency pairs, ‘Majors’, are traded with the lowest spreads, while rare pairs ‘exotics’, are traded with significantly higher spreads. Another factor is the amount of a deal. Middle sized deals have standard tight spreads, while deals that are either too big or too small have much higher spreads due to the risks involved. The status of a trader influences their spread amount as well. If you are a high-profile trader with a premium account, you will enjoy tighter spreads. Again, as mentioned before, the market conditions influence spread as well. During peak times of high market activity, spreads will be tighter than trading in the off-market hours.

When trading forex, it is important to take all these aspects into consideration so that you come out more profitable with your trades.