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What is a Spread in Forex Trading?

After we know what is forex? And what are the currency pairs that are traded in the forex market? In this lesson, we learn about the price difference or spread in forex.

What is a Spread in Forex Trading?

To better understand the impact of forex, you must first understand the general structure of any forex trading. Deals are made through brokers who receive a fee for their services.

The trade difference between the bid and ask price - is called the 'spread'.

The Bid-Ask Spread Defined

Spreads in forex are two prices: the buying (bid) price of a particular currency pair and the selling price (the ask). If a trader buys his currency and has to sell it immediately, its price will decrease.

When you buy a new car, you will pay the current market price for it. At the time the car is moving from its place, its value will decrease, and if you want to sell it, its price will decrease and take less money on it.

The depreciation of the difference is shown in the car example, while the profit of the trader shows the difference in forex trading.

Forex market makers are the ones who set the spread

The forex market is different from the New York Stock Exchange, where the old trading took place in an actual area. Because the forex market is practically an over-the-counter market for small stocks, where trades are facilitated by specialists called "market makers".

The buyer may be located in London and the seller may be in Tokyo, so an intermediary is required to coordinate the transaction.

The specialist who facilitates the circulation of his work may be present in a third city. whose responsibilities are to ensure the orderly flow of purchase and sale orders for those currencies, which must provide a seller to every buyer and vice versa.

In fact, the specialist takes risks, for example, if he orders a bid or purchase at a certain price before finding a seller, the value of the currency increases.

The specialist is responsible for filling in the accepted purchase order and may accept the sale at a higher price than the purchase that he is obligated to fill.

Note: In most cases, the change in value will be slight, and the market maker will still make a profit.

To accept the risk and facilitate the trade, the market maker keeps a part of each trade they make. The "spread" is the percentage that they keep.

How is the spread or spread in forex calculated?

As we mentioned earlier, the price difference is the difference between the purchase price and the selling price, and the price difference is usually determined according to the volume of orders and offers. currencies. The trader does not need to calculate it manually as the trading platform calculates the spread automatically.

Let's take an illustrative example of this through the trading platform or the MetaTrader 4 platform:

Spread or spread in forex

In the example, we open a deal on the AUD/USD pair and as shown in the execution box has two exchange rates, the first price is 0.71520 which is the asking price, above the button for making a buy deal for the pair, while the other price 0.71512 is the bid price, above the special button Negotiating a sale deal for the husband.

The Cost of the Spread

In the previous example, a spread of 0.00008 Australian Pounds (AUD) does not seem like much, but even a tiny spread builds up quickly as the trade volume increases. Forex currency trades usually involve larger amounts of money.

As a retail trader, you can trade 1 lot of 10,000 units of AUD/USD. But the average trade is much larger, at around A$1 million/US$. The spread of 0.00008 on this larger trade is £400, which is a much bigger commission.

How to Manage and Minimize the Spread

You have two ways to reduce the cost of these spreads:

  1. It is better that you should trade the most suitable hours because many buyers and sellers are present in the market. As the number of buyers and sellers for a particular currency pair increases, competition and business demand rise, and market makers often narrow their spreads to get them.
  2. You should avoid buying or selling minimally traded currencies. Because many market-makers compete for business when you trade popular currencies such as the GBP/USD pair. If you are trading a poorly traded currency pair, there may be only a few Market makers who accept this trade.

What is the unit of measurement for the price difference?

The price difference between the buying price and the selling price is measured in a unit called a pip and a pip is a unit of measurement that traders use in the forex market to calculate the smallest movement that occurs in the price movement of a currency pair. Like the pairs containing the Japanese yen, the pip is calculated for the second decimal digit from the left, and the word (PIP) is an abbreviation of the term (percentage in point) and this term means the percentage change represented in a point. We have discussed what is the PIP in Forex in detail in another educational article.


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