The first concept one comes across as a beginner to Fx trading is the spread, which is nothing but the difference between the buying price (ask price) and selling price (bid price) for a currency pair. It contributes to your overall trading costs and greatly impacts your earnings and losses, so it is essential to understand how spreads function and how it affects your trade.
Brokers make money through the spread. If you go in on a trade, you enter at the ask and exit at the bid. So, essentially, the spread is the cost to execute the trade, and they are typically expressed in pips-the smallest unit of price movement within the Forex marketplace. For example, if the ask price of the EUR/USD currency pair is 1.1500 and the bid price is 1.1502, the spread will be 2 pips. Thus, for the break-even scenario, the price has to move 2 pips in your favor after entering the trade.
The size of the spread may be affected by some factors, among which are currency pairs being traded, the brokerage firm being utilized, and existing market conditions. Highly liquid currency pairs such as EUR/USD or GBP/USD tend to have tighter spreads because they generate huge volumes among themselves. Wider spreads will only add to higher trading costs as exotic currency pairs or less liquid ones tend to have wider spreads. The more wide the spread, the more challenging it would be for the price to act in one direction favorable to your pip gain.
There are two types of spreads: fixed and variable. A fixed spread does not change regardless of the market condition. This means that no matter what happens in the market, the spread for a particular currency pair will be the same. Fixed spreads are generally preferred by traders who want to know exactly what their costs will be when entering and exiting trades.
Variable spreads change according to the market condition. If it’s one of the bigger sessions of liquidity, spreads would generally be tighter. The higher the volatility and especially the period in which these reports occur, this could typically result in making the spreads quite wide. Therefore, traders need to pay attention to the changing spreads, especially when determining the trade entry since the costs are significantly added and can really be a factor for short-term trades.
It will also affect your trading strategy, especially when you trade in short time frames. Day traders or scalpers, who make their earnings as the prices of the difference of a very small amount, will lose part of their potential profits from the spreads. For this reason, most of the short-term traders focus on low spreads pairs since for them a small difference can be great over all. On the other hand, a long-term trader may not be affected too much by the spread since they hold a position for longer durations and the spread cost is negated by the movement of the market over time.
Spreads are part of the market structure in FX trading, but they do not need to be overlooked. This will enable you to make informed choices regarding your trades and suitable trading cost control. Whether you are a new or experienced trader, spreads are an enhancement that will enhance your overall trading experience with eventual success in operations.