The spread in forex is the main way traders are charged for opening and closing positions. Learn more about the spread and how it’s calculated.
What is a spread in forex?
The spread in forex is the difference between the price your broker quotes you to buy a currency (the ask) and the price they quote you to sell it (the bid). You’ll always buy slightly above the market price and sell slightly below it – this discrepancy is called the bid-ask spread.
The spread in forex is the primary cost of trading – think of it as an alternative to a commission fee – which is why it can vary from broker to broker.
A high spread refers to a large difference between the ask and bid price of the currency pair. Meanwhile, a low spread refers to there being just a small difference between the currency pair’s ask price and bid price.
How is the spread calculated in forex?
To calculate the spread in forex, you need to work out the difference between the buy and the sell price in pips. For example, if you’re trading GBP/USD at 1.2151 /1.2153, the spread is calculated as 1.2153– 1. 2151, which is 0.0002.
The spread is usually measured in pips, which is the smallest unit of the price movement of a currency pair. For most currency pairs, one pip is equal to 0.0001 – except for the Japanese Yen, which is only quoted to 2 decimal places. So, in our GBP/USD example, 0.0002 would be a 2-pip spread.
How the spread works in forex
The spread in forex will work slightly differently depending on what’s on offer from your broker. Generally, there are two main types of spread you might come across: fixed and variable.
- A fixed spread always remains the same regardless of volatility
- A variable spread can tighten and loosen with volatility, to account for different levels of risk
A fixed spread is offered by providers that operate as market makers themselves, acting as a counterparty to their clients’ trades, while variable spreads are more common among providers that pass on third-party pricing.
While fixed spreads are beneficial during periods of high volatility when spreads typically widen, variable spreads come with the potential for lower costs during more stable market conditions.
Some forex traders prefer fixed spreads because they can be reasonably sure of what price they’ll pay and the costs they’ll incur. However, even fixed spreads can be subject to slippage – which is what happens when the market is moving quickly, and the price changes between the level you place your order at and the price your broker can execute at.
What influences the cost of spreads in forex?
The cost of the spread in forex depends on market conditions and the agreement you have with your broker – i.e. whether you’re on fixed or variable spreads.
If we assume a variable spread, then the costs of trading are greater in volatile markets to account for the increased risk to your broker, and lower during periods of stability.
There are a range of factors that can drive volatility, but in forex it’s mainly economic data releases and breaking news. This makes it important to stay on top of dates in an economic calendar to see what upcoming events could influence the currency pair you’re trading.
The FX pair you choose also impacts the cost of the spread. The currency pairs of emerging markets and economies typically have a high spread compared to major currency pairs due to their lower liquidity levels.
How does the spread affect profit in forex?
The spread affects profit in forex because you’ll always have an initial barrier to cross before your trade is in profit – as you’ll always buy above the market price and sell below it.
For example, if the market for EUR/USD is trading at 1.0949, with a 0.9 spread, you’d open a buy position at 1.0950. This means you need the underlying to move 0.45 points above the current market price before your trade sees any capital gains.
What does raw spread mean in forex?
A raw spread forex account is a type of trading account that provides a direct link between the trader and the market – which means there are no spreads added by a broker. The benefit is that there are lower costs per trade, and any potential gains could be slightly higher because there’s no spread to cover before the position moves into profit.
However, a lot of raw spread accounts feature commission charges instead of spread charges.
The catch is that by offering raw spreads, brokers are essentially passing on the cost of trading to the individual. This means instead of the spread, you may have to pay a higher commission fee for each trade executed.
Get low spreads with City Index
Trade over 84 global currency pairs with low trading costs – including EUR/USD from just 0.7 points. To get started, simply:
- Open a forex trading account – with City Index, you can choose between a standard trading account or an MT4 trading account
- Find a forex pair to trade – we offer over 84 global currency pairs on our award-winning platform
- Decide whether to go long or short – this will depend on whether you think the base currency will strengthen or weaken against the quote
- Build a strategy – you’ll need to create a forex strategy for entering and exiting the trade, which should include suitable forex risk management
- Place your trade – then monitor the market and close the position when you’ve reached your profit target or maximum loss
Learn more about how to trade forex
Alternatively, if you’re not ready to trade on live markets just yet, you can open a demo trading account. You’ll have access to our full range of currency pairs and can take your position on their price using virtual funds instead of real cash.
Learn more about forex trading with City Index
If you’re looking to learn more about currency markets, we have a forex trading course for beginners in the City Index Academy. We have a huge range of different lessons that might be of interest to new FX traders, including an introduction to forex trading, how to use technical analysis and how to enter a trade.
See our full range of courses for beginners