Foreign exchange, otherwise known as forex, is a large industry that makes it possible for people to buy and sell currencies for profit. that it The most liquid market in the worldwith a daily turnover of more than $5 trillion.
This asset is very popular with those who decide to invest for the long term and those who prefer trading with shorter timeframes, such as day traders or scalpers.
However, you are here for a reason: to understand how to succeed in making profits by exchanging the currencies of different countries. You need to Learn the concept of spread in forex; It’s all about it.
In this article, we will look at how foreign currency pairs are quoted and delve into the concept of spread.
What is spread in forex?
Forex brokers do not charge commission for their services. instead of, They make money from currency differences that occur between the bid and ask prices. These spreads usually depend on the currency pair.
For highly liquid currency pairs Like EUR/USD and GBP/USD, the Diffusion is usually noticeably weak. And to Extremely not liquid Pairs like TRY/SGD and GBP/BRL, the spread It is usually wide Because their demand is a bit low.
Sometimes offering forex trading services using spreads instead of commission can be very profitable for companies in this industry. In fact, many money transfer companies have changed their business model to focus on spreads.
Types of spreads in forex
Basically there Two main types Spread in forex: Fixed and variable.
Fixed spread It is a case in which the broker guarantees it The difference between bid and spread is the same. In most cases, these spreads are offered by brokers who act as a market maker or dealing desk.
A dealing desk is a situation where a broker buys a large position in a currency pair and then offers it in smaller sizes to traders. They simply act as a counterparty.
a Variable spread It is the case of a currency pair spread It changes with time. Spread It expands when there is significant volatility And Eases when there is Limited volatility.
For example, the EUR/USD spread could be 2 in normal periods and then widen to 20 after a major event such as an interest rate decision. The benefit of variable spreads is that They spend on repricing and be more transparent.
How is spread calculated in forex
The spread of the currency pair is calculated by Subtract the bid from the ask price. Let’s look at an example, where EUR/USD is trading at 1.1050/1.1055. In this case, the spread for the pair is calculated as 1.1055 – 1.1050, giving it a spread of 5 pips.
Some currency pairs such as the USD/JPY are priced differently. The USD/JPY pair can be quoted as 111.15/111.20. In this case, the spread for the pair will be 5 pips.
How are currencies priced in forex
The concept of currencies in forex trading is a relatively simple concept as it involves the buying and selling of currencies. Indeed, we can say that Everyone who has cash is a forex trader Because holding one currency over the other is a sign that they believe their currency will gain value.
For example, if you hold US dollars in your account, you simply believe that the value of the US dollar will continue to rise.
Currencies are priced in pairs Because you need to exchange one currency for another. Examples of currency pairs are EUR/USD, GBP/USD, and EUR/GBP. In this case, The first coin is known as the base currency while the second one known b quote currency.
As such, if the EUR/USD is trading at 1.1025, that means that 1 Euro is equivalent to 1.1025 USD. As such, it means that the US dollar is more valuable than the Euro.
for most currencies of developed countriesPairs It is easily quoted. In this case, the official exchange rate is almost the same as the one at which you will exchange currencies. but, in a lot Developing and Emerging Marketsthese officials Usually the exchange rate is different than what people get in the market.
Forex currency pairs have two major prices, known as bid and ask. Bid is the maximum price that the buyer is willing to pay while the ask is the maximum price that the seller is willing to pay.
The bid is usually on the left side while the ask is on the right side of the coin price. A good example of this is shown below.
Factors affecting currency spread
Three factors influence the spread of a currency pair, including:
market fluctuations
For variable spreads, market volatility plays an important role in the spread. In most periods, brokers will often adjust the spread to reflect market volatility.
Good brokers tend to provide a warning before adjusting the spread.
currency pair liquidity
Liquidity is an important factor that determines the spread of a currency pair. Highly liquid pairs Such as EUR/USD and GBP/USD It tends to have a very thin spread.
On the other hand, pairs like GBP/TRY and EUR/BRL have wider spreads.
Market news
Another important factor affecting the spread of a currency pair is Market news. In most periods, the currency pairs spreads tend to be the same widely when there is substantial market news.
For example, some of the most popular market news are in the Federal Reserve and political news.
Related “ How do you trade the news?
How to choose low spread pairs
Forex experts recommend choosing Low spread currency pairs rather than those with wide differences. Usually these are pairs Easy to get in and out.
Some of the most popular currency pairs with the smallest spreads in the market are EUR/USD, USD/JPY, and GBP/USD.
Forex minor Such as EUR/GBP, AUD/GBP, and AUD/JPY It has wider margins. strange Currency pairs such as GBP/TRY and EUR/PLK It has very wider margins.
summary
In this article, we have looked at the concept of spread and how it works. We also evaluated how these variances are calculated and the main factors that influence them.
In some cases in particular When you have a high degree of confidenceIt makes sense to trade pairs that have wider spreads. However, in most cases, we recommend focusing on highly liquid currency pairs.