Understand Deeply on Forex Spreads. Why each open position starts with a negative profit!



What are trading spreads?

In online trading, spread is the difference between the ask price and the bid price of a financial instrument. In Forex trading, it is usually measured in pips.

In market theory, the spread is the difference between the currently highest price a bidder is offering and the currently lowest price a seller is asking for. As different bidders and askers might only be willing to buy certain volumes, and because there are small time delays in the market prices, the spread is in practice influenced by a large set of traders.

This is also the reason why in very liquid markets — markets with many active traders — the spread is usually much lower than in markets that are not very liquid.

In forex trading, this has the effect that often, the spread is lowest on EUR/USD (trading euros and US dollars), as it is the most traded currency pair.

Online brokers usually take a markup on the spread as their source of revenue. The spread is a part of the cost of trading for every trader. That is why the spread on different financial instruments and asset classes is an important factor when choosing a broker.

More on spreads

Let’s consider an example of a spread.

If the price of the EUR/USD is listed as bid 1.0000 and ask 1.0001, the seller would be able to sell their position at 1.0000 while a buyer would have to pay the price of 1.0001. This means the currency spread in this case is 0.0001. The usual measure for the spread is pips and so the spread would be 1 pip.

There are two types of spread: fixed and floating.

Fixed spread

A fixed spread refers to a fixed number of pips set as a spread by a broker. The spread does not change, even during the release of news reports and Asian forex trading session activity.

Variable or floating spread

A floating spread means that the number of pips you pay as a spread are subject to change by a broker. For instance, if you enter a buy order at a particular time in the day, then the spread may be 2 pips. During heightened periods of volatility, such as when a news report is released or low periods of low volume such as the Asian session, the spread may increase to 3 or 4 pips.

Most brokers use spreads as their transaction cost to charge traders that’s why each open position starts with a negative then later on continues to profit, therefore if you cancel the order earlier the broker will just deduct the spread amount from your capital.

Other brokers chargers commission which is a fixed amount depending to the lot size the more the lot is higher then the commission is also raised.

If you have any question on today’s class please fell free to ask in the comment section below and we would pass by each question and give you instant feedback.

Written by Raymond Heriel 
Chief currency Analyst at Pro Fx Tigers
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