Significance of SPREAD in forex trading

This article will help you to understand what is Spread and what is the real significance of spread in forex trading.

WHAT IS SPREAD?

Spread is the difference between Bid and Ask prices of a currency pair.

So what is a bid price and ask price.

Bid price is the market price at which a currency pair can be sold.

Ask price is the market price at which a currency pair can be bought.

EXAMPLE:

The above figure is a screen shot of the market window in an mt4 trading platform.

See the encircled pair, the currency pair is GBP/USD. The price of that pair can be written as

GBP/USD      :      1.4986/88.

The price written on left side is the BID price. Here it is 1.4986

Price written on right side is the ask price. Ask price here is 1.4988

Meaning:

This means that if you want to buy ONE GBP you have to sell 1.4988 USD. Likewise if you want to sell ONE GBP you will have to buy 1.4986 USD. In simpler terms:

Buy rate of GBP=1.4988

Sell rate of GBP=1.4986.

See the difference of 2 pips between the buy and sell rate that is called Spread.

The BID and ASK prices keep on changing depending up on the market movement.

HOW SPREAD AFFECTS A TRADE:

Let’s take the same example shown above. According to the above figure if we are going to trade GBP/USD

In a buy trade: Every buy trade is done to buy currency pair at a lower price and sell at a higher price.

So in the above case you will have to buy GBP at a price of 1.4988 as that is the ASK price of market. But at the same time the sell price or BID price is 1.4986. That means you can sell the GBP you bought only at a price of 1.4986 (which means at a loss of 2pips). For your trade to be profitable the BID price has to move above 1.4988.

Exact reverse happens in a sell trade.

 SIGNIFICANCE OF SPREAD:

• The more the spread the more risk in getting a profitable trade:

As you have seen in the above example only when a currency pair move to cover the spread ,you will be profitable in a trade. So currency pairs with 1 pip spread are easier to trade than currency pairs with 6 or 8 pip spread.

• Spread is where the broker makes his profit:

Some brokers provide the major currency pair EUR/USD at a spread of 1 pip where as some other brokers are providing the same currency pair at a spread of 3 pips. So while selecting your broker among other things take in to consideration the spread levels that broker is offering.

Here is the link to a site with an excel sheet comparing various spread given by major forex brokers. http://www.myfxbook.com/forex-broker-spreads.

• Consider spread while placing stop loss

While placing stop loss for the trade you have taken, consider the spread to reduce unnecessary loss.

• Spread plays a major role while trading forex with lower time frames.

While you are trading time frames like m1 and m5 spread will have a significant effect. Scalping strategies in forex are usually done with lower time frames with 5 or 10 pip profit levels and tight stop loss levels and at that time try to select currency pair with very low spread levels.