As the largest financial market in the world, forex gains a lot of traction every day. But as lucrative as it is, it’s not free to use. Forex spreads, in particular, are one of the main trading costs in the market that you need to get to know to enhance your profitability.
In this article, we will break down the concept of forex spread, its types, and its importance in the world of trading. By the end of this blog, you’ll know more about the role of spreads in determining trading costs, profitability, and execution efficiency. Without further ado, let’s get into it.
What is Spread in Forex Trading?
Forex spread is defined as a difference between the bid and ask prices of a currency pair. The bid price is the highest price the broker is willing and able to pay you to buy the currency pair from you. On the other hand, the ask price is the lowest rate at which the broker is willing and able to sell the currency pair to you.
Every time you look at the price of a currency pair, you’ll see two rates. The number on the right side is usually the bid price, whereas the left number is dedicated to the ask price.
So, if the EUR/USD pair is quoted as 1.4079/1.4081, that means that the broker is willing to pay $1.4079 to buy the pair from you. At the same time, you should pay at least $1.4081 to purchase the pair from your broker. This brings the EUR/USD forex spread to 2 Pips (percentage in points).
Spread is the primary cost of entering a trade. It represents how much you need to overcome before your trade becomes profitable. At the same time, the broker’s profit is often earned through forex spread, especially with the market-making brokers.
Types of Forex Spreads
There are four types of FX spreads you need to know about to ensure your trades run as smoothly and as profitably as possible:
1- Fixed Spreads
The main characteristic of a fixed forex spread is that it remains constant regardless of market conditions or liquidity levels. Many traders look for this type of spread because it makes trading costs predictable, which is perfect for beginners who need a fixed cost structure.
At the same time, fixed spreads can be wider than variable ones, especially during volatile market conditions, which might increase the overall costs of trading.
For example, the EUR/USD currency pair might have a three-pip fixed spread at all times, meaning that no matter when or where you trade, you’ll need to pay 3 pips first for your trade to become profitable.
2- Variable (Floating) Spreads
There are also variable or floating forex spreads, which change based on market conditions, such as liquidity and volatility. They are typically tighter during normal market conditions, therefore often preferred by advanced traders and scalpers.
Still, during volatile periods, like news releases or low liquidity times, they can widen dramatically and increase trading costs.
Following our previous examples, a variable spread on the EUR/USD pair may range from 0.5 to 2 pips during normal hours but could increase to 5 pips during major economic news events.
3- Commission-Based Spread (ECN)
Many ECN brokers offer their traders better liquidity in exchange for a small commission on their trades, which traders need to pay in addition to a tight spread. While these types of tighter forex spreads could make trading look more cost-efficient due to the lower amount of spread, they do, in general, increase the total cost due to commissions. This makes commission-based spreads not ideal for beginners or very small traders.
If you’re looking for low spread forex brokers who don’t charge you both spreads and commissions, count on ITBFX. Forex spreads on our ECN accounts start from 0.0 pips, and our standard and nano accounts only require traders to pay a small, tight spread. For more info, you can visit our account types page.
4- Market-Maker Spread
Lastly, there is the market-maker spread, which is a means for market makers to provide liquidity. They typically offer wider spreads but compensate with lower commissions.
Market-maker spreads are preferred by some traders because they create a simple fee structure with no need to worry about commissions. At the same time, because these spreads tend to be wider, particularly during volatile periods, many traders might try to stay away from them.
How Does a Forex Spread Affect Trading Costs?
Based on your trading style and preferences, forex spreads could impact your trading in various ways. In this section, you learn how these FX spreads impact your trading costs, how they interact with different creating strategies, and, most importantly, how you can calculate your profitability considering these spreads.
How the Spread Impacts Your Trade
First and foremost, it’s important for you to pay attention to the forex spread upfront before entering the market. This means you need to determine what direction, and how much the price must move for you to begin making profits.
For example, if you’re planning to trade EUR/USD and it has a forex spread of 2 pips, you would need the price to move two pips in your favor just to break even before making any profit.
Impact on Different Trading Styles
What’s more, different trading strategies are impacted by forex spreads differently.
For example, scalping, a type of day trading strategy, involves making many quick trades to profit from small price movements. A tighter spread is crucial for scalpers to avoid significant losses only from spreads in forex.
Day trading itself focuses on intraday movements, which also require tight spreads crucial to help traders who prefer this strategy maintain profitability with small price movements.
Lastly, in strategies such as swing trading and position trading, spreads matter less for traders because they hold positions for days or weeks. However, they still contribute to the overall cost of a trade, which makes being aware of them and trading accordingly essential.
Calculating Profitability with Spreads
Now, as the most important step, how do you calculate your profitability with spreads in forex? You know the basics; trading with wider spreads means larger price movements are required to reach profit levels and vice versa. So, let’s get into a real-world example to help you determine your forex trading profitability when taking spreads into account.
A trader enters EUR/USD at 1.1050 with a 2-pip spread and exits at 1.1070. In such a case, the trader needs at least 2 pips to break even. The difference between the exit price (1.1070) and the entry price (1.1050) is 20 pips. However, the trader must subtract the 2-pip spread to calculate the net gain.
Net gain = Total Gain (20 pips) – Spread (2 pips) = 18 Pips
If the trader exits at 1.1070, the net gain is 18 pips, which is already a profit. However, to achieve a net gain of 20 pips, the trader would need the trade to move 22 pips in their favor (20 pips profit + 2 pips to cover the spread).
Factors Impacting Forex Spreads
The most important factors that help brokers determine forex spreads include:
- Market Liquidity: High liquidity leads to tighter spreads. This is because more participants and volume in the market lead to narrower differences between bid and ask. At the same time, low liquidity results in wider spreads, as fewer buyers and sellers lead to less competition and price volatility.
- Market Volatility: Forex spreads widen during periods of high volatility (e.g., after economic data releases, geopolitical events, etc.). For example, when the U.S. Federal Reserve makes an interest rate decision, spreads on major currency pairs may widen significantly. It’s important to always follow a reliable forex calendar to better predict spreads in forex trading and improve your fundamental analysis game.
- Time of Day: You should also look for the best forex market hours to trade. Spreads in forex trading are typically tighter during active market hours (e.g. when London and New York markets overlap). During quieter hours, such as late evening to early morning (Asian session), spreads may widen due to lower market activity.
- Currency Pair Liquidity: Major currency pairs, such as EUR/USD, GBP/USD, and USD/JPY, tend to have the tightest spreads due to high liquidity. At the same time, minor pairs like EUR/GBP or AUD/JPY have wider spreads due to lower liquidity. Still, currency pairs with the widest spreads, lowest trading volumes, and highest risk levels are exotic pairs, which include currencies from emerging markets (e.g., USD/TRY, EUR/ZAR). Trading these pairs also requires a rigorous risk management strategy.
How to Minimize the Impact of Spreads on Your Trades?
There are some steps you can take to minimize the impact of forex spreads on your trades. Doing so is all about choosing the right brokers and platforms and making sure your timing is right. Below, you can learn more.
Choosing the Right Broker
The first step is to choose the right broker. Compare brokers based on spread offerings, commission structures, and overall trading costs. Also ensure that your broker of choice at least provides competitive spreads for the currency pairs you specifically plan on trading.
Especially for scalpers, low forex spreads are critical. Check and see if you can scalp on your chosen broker’s website and ensure they offer narrow forex spreads during regular market conditions. If they offer a commission based model, that’s even better.
ITBFX aims to help clients reach maximum forex trading profitability by offering super tight spreads, starting from 0.0 pips, as well as some of the lowest commissions on the market. Check out our website to learn more.
Timing Trades for Optimal Spread
Timing is another contributing factor. Trade during peak market hours to take advantage of lower spreads (London and New York sessions) and avoid trading during news events that might lead to wider spreads.
Advanced Trading Strategies
The last step is to up your own trading game. Take your time when developing your training plan and trade with discipline thereafter. Improve your strategies by using limit orders to enter the market when the spread is tight. It’s also best to avoid market orders during periods of higher volatility.
Myths and Misconceptions About Forex Spreads
Below, you can find some of the most common myths and misconceptions about forex spreads. Being aware of these myths can help you enhance your trading profitability.
- “A Lower Spread Means Lower Costs” Not always true. A broker with a lower spread may charge a higher commission or have a less favorable execution speed.
- “Fixed Spreads Are Always Better” Fixed spreads are predictable, but they can be wider than variable spreads when market conditions are calm.
- “Spreads Don’t Matter in Long-Term Trading” Even for long-term traders, spreads impact overall profitability, especially when trading large positions.
Conclusion
Forex spreads are ways for brokers to make money from their users’ trades. These spreads are one of the most important trading costs every trader should recognize and learn to work around early on.
Different types of spreads offer different benefits and disadvantages, making it even more important for you to learn them by heart and refine your trading by making more informed decisions.
Some of the things you can do to minimize the impact of spreads in forex trading include choosing the right broker that will charge you competitively, making sure your timing is right, and improving your trading strategy.
Ready to take control of your trading costs and maximize your profits? Start by exploring brokers with tight spreads and low commissions today. Visit ITBFX to discover how our trading solutions can help you achieve your financial goals.
A forex spread is the difference between the bid (buy) and ask (sell) prices of a currency pair, representing the primary cost of entering a trade.
Spreads directly impact profitability by requiring the price to move in your favor by at least the spread amount before you break even or make a profit.
Choose brokers with tight spreads, trade during peak market hours, and use advanced strategies like limit orders to reduce trading costs.
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