Forex Foreign Exchange Spreads

The concept of spreads in the forex market is surprisingly complex and often not well understood. But this is one of the major parameters that affects your trading profitability.

Spread is the difference between the ask price (the price you buy at) and the bid price (the price you sell at) quoted in pips.

For example, we say the quote of GBP/USD is 1.8281/84, it means that the bid price of GBP is 1.8281 USD and the ask price is 1.8284 USD. In this case the spread is 3 pips.

Spread is the component through which the brokers make money. Wider spreads result in a higher ask price and a lower bid price. This means, you pay more when you buy and get less when you sell, making it more difficult for you to realize a profit.

Spreads greatly affect the return on your trading strategy. As a trader, your prime interest is buying low and selling high. A half-pip lower spread doesn't sound like much, but it may turn a profitable trading strategy into an unprofitable one.

A tight spread is better for your forex trading only when it is coupled with good execution. Quality of execution determines whether you actually receive tight spreads.

If your terminal shows a tight spread, but your trade is filled a few pips to your disadvantage or is mysteriously rejected, it means that your broker is displaying tight spreads but effectively delivering a much wider spread. Therefore be aware of rejected trades, delayed execution, slippage, and stop-hunting which cancels the effects of a tight spread trading.

Forex Spreads must always be considered in conjunction with depth of book. In many cases, the brokers offer a tight spread only to a capped trade sizes that are grossly inadequate for typical trading strategies.

These days all forex broker claims to have the tightest spreads in the industry. But spread policies differ considerably from broker to broker, and the transactions are often not exactly transparent. Some offer fixed spreads that are guaranteed to remain the same regardless of market liquidity. But such fixed spreads are generally higher than the average variable spreads.

Other brokers offer traders variable spreads depending on market liquidity. For them, spreads are tighter when there is good market liquidity but widens as liquidity drops. Some brokers even offer different spreads for different clients.

For larger accounts or those who make larger trades, may receive tighter spreads than others. Therefore it will be ideal to find out a broker who offers the tightest variable spreads possible with no discrimination.