Spreads Meaning in Forex Explained for Beginners

In this article, we will explore the meaning of spreads within forex trading. You will learn about the ‘bid’ and ‘ask’ quotes that you will receive from forex brokers when you trade on the financial markets, you will learn what forex spread indicators are, how spreads are measured and calculated in forex trading, the different types of spreads that exist, and much more!

Spreads Meaning in Forex Explained for Beginners
[image: pexels by burak kebapci]

What Is A Spread In Forex?

Simply put, spreads are the difference between the selling price (the bid or sell price) and the purchasing price (the ask or buy price). Here’s a visual representation to demonstrate what you might expect to see:

[image: forex.com]

For instance, in this example above, we can see the price quotes for the EUR/GBP (Euro to British Pound Sterling) currency pair during a live trading session in the forex markets. The spread is indicated in the box to the far right (which is labeled as ‘distance’ here).

The spread size will vary according to a variety of influences. For instance, the popularity of those particular currencies at that time, the strength of the currencies, the volatility of the currencies and the currency pair in general, how large your trade is (in terms of the capital invested), and the provider (or broker) you are using.

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Understanding Currency Pairs

Let’s delve a little deeper into currency pairs. Every currency pair will provide two prices. The first price is what is known as the ‘base currency’, and the second price is known as the ‘counter currency’ (also known as the ‘variable’ or ‘quote’ currency’).

● So the currency pair would look like this: Bid Price = (USD) 1.1327 / Ask Price = (JPY) 1.1337

In the example above, we can see the USD/JPY currency pair. In this instance, the base currency would be USD (United States Dollar), and JPY (Japanese Yen) would be the counter currency.

These equations essentially show you how much the counter currency is worth against the base currency.

The majority of forex currency pairs are traded without having to pay any form of sales commission. But with that being said, a cost will be inserted or included within the spread, and this will come in the form of a cost given for a trade placed.

How Spreads Are Measured In Forex

Forex spreads are calculated by taking the final largest numbers from the bid and ask prices.

Here’s an example to demonstrate:

If the buy price is 1.37564, and the sell price is 1.24567 for the GBP/USD currency pair, this would mean that the spread would be 0.12997 (and as we mentioned earlier, the spread is just another way of referring to the ‘distance’ between two price quotes).

● So the equation would look something like this: (GBP) 1.37564 - (USD) 1.24567 = 0.12997

Pips

Moreover, spreads are typically measured (or expressed) in pips. A pip refers to the smallest amount (or unit) within the movement of prices in a currency pair. In the majority of currency pairs, one pip would be equal to: 0.0001.

For instance, if we’re looking at the EUR/CHF currency pair (Euros to Swiss Francs), and the Euro price (Bid price) is 1.1021, and the Swiss Francs price (Ask Price) is 1.1024, this would mean that the amount of pips would be equal to 3 pips.

● So the equation would look something like this: Spread = (CHF) 1.1024 - (EUR) 1.1021 = 3 pips

The Bid Ask Margin

You may also hear traders discuss the ‘Bid Ask Margin’. This refers to the spread percentage (or rather the difference between the buy and sell price quotes when divided by the ask price).

The equation would look something like this: Margin % = Buy (Ask) - Sell (Ask) / Ask Price x 100

● Margin = (GBP) 1.37564 - (USD) 1.24567 / 1.24567 x 100 - 10.434%

Forex Spread Indicators

When you are using a trading platform such as MetaTrader 4 with a provider such as MTrading, you will be constantly monitoring the forex markets by way of graphs, together with predictive tools, and many other resources.

When you are tracking a particular currency pair, you will be able to see the spread indicator displayed as a curve on the graph, and this will inform you as to which direction the spread is heading in, in relation to the buy and sell prices.

Moreover, you will notice that when you compare more standard currency pairs such as GBP/USD that have tighter spreads, with more ‘exotic’ currency pairs (e.g. USD/BRL - United States Dollar to Brazilian Real), the exotic pairs will tend to have wider spreads.

Types Of Spreads

The two main types of spreads that you will see in the forex markets are ‘Fixed Spreads’ and ‘Variable Spreads’.

Fixed Spreads

Fixed spreads never change, meaning that market conditions do not affect them. When brokers offer fixed spreads, they do so via the ‘dealing desk’ model (operating as a ‘market maker’).

Through the dealing desk, the broker will then purchase large quantities of trading positions through their liquidity providers, and they will then proceed to offer these positions to the traders in much smaller sizes.

Variable Spreads

Variable spreads always change, and are affected by market conditions. These spreads are provided by ‘non dealing desk’ brokers.

Brokers reach out to many different liquidity providers in order to secure trading positions that they can offer to their clients with this spread type.

Moreover, the broker has no influence over the spreads, and therefore, the spreads will change in accordance to the supply and demand of the currencies, as well as the volatility of the market at any given time.

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