If you are a dealer in the forex market, you will time and time again hear about the term spreads. To explain what this term means, we shall take a look at how the forex markets work. Prices in the forex market are usually represented in the form of currency pairs where the value of one currency unit is displayed relative to that of another. For instance, if the currency pair under consideration is USD/Euro, the value of the USD will be presented relative to that of the Euro.
The buying customer quotes a currency in what’s known as a “bid” while the selling customer quotes it using the “ask”. Since the “ask” is higher than the “bid”, the difference between the two is what’s known as the spread. It is the amount that goes to the forex broker as the cost for the services offered.
Say you are trading the GBP/USD currency pair. Your “bid” is 1.1657 while the seller’s “ask” is 1.1651. The spread, in this case, is 0.0006. It is usually measured in terms of “pips” which is presented as a percentage.
Types of Spreads in the Forex Market
Now that we have adequately answered the question: “what is spread in forex market?” we need to find out the various types of spreads you are likely to come across as a forex trader. As such, spreads can be of two types: fixed or variable spreads.
1. Fixed Spread
Brokers operating as market makers are the ones that usually offer fixed forex spreads. Changing market conditions have no effect on fixed spreads. Brokers who provide automated trading accounts have the power to determine prices and therefore are more at home with a fixed forex spread.
Fixed spreads have several advantages including that the capital requirements are smaller. If you are a trader, fixed spreads are cheaper and work well when you have little money to invest in forex. When it comes to the calculation of transaction costs, fixed spreads provide for a more predictable option. Every time you decide to trade, you know exactly how much you are going to pay.
One of the disadvantages of trading with fixed spreads is the recurrence of price quotes owing to the fact that pricing is determined by the forex broker. Also, the broker isn’t in a position to quickly adjust the spreads in response to prevailing market conditions. Such traders are fond of blocking price offers from buyers and instead suggesting new ones. That can be annoying.
2. Variable Spreads
Unlike their fixed counterparts, a variable forex spread is ever changing. For that reason, the spreads you used today may not be there tomorrow. It is the non-dealing brokers who offer variable spreads. They are great because they eliminate the need for re-quotes. It is the market conditions that determine these spreads. The pricing using variable spreads is more transparent since it isn’t fixed by the broker.
However, a variable currency spread may reduce the amount of profits traders can enjoy if they widen too much. This affects new traders as much as it affects scalpers. Before you finish saying pread’, a profitable currency pair would have turned into an unprofitable one.
Now that you know the answer to the question: “what is spread in forex market?” you are better placed to make wise investing decisions. For you to get the most profits in currency trading, you must always choose the lowest spreads.