What is Spread?
What is Spread
In Forex trading, the spread of any currency pair or other CFD product may vary depending on a number of factors. These factors include institutions' pricing policies, account types, market and liquidity conditions.
What is Spread?
The difference between the buying and selling quotes of any financial instrument is called spread. For example, the selling price of many investment instruments such as stocks, futures contracts and options at a certain moment is slightly above the buying price, and this difference is called spread.
Likewise, there is always some difference, in other words, spread, between the buying and selling prices of products based on stocks, commodities, indices and bonds in the Forex market. The fact that the Forex investor's position starts at some loss when he starts trading is due to the existence of the spread.
The Role of Spread in the Forex Market
Spread rates vary depending on the liquidity of the product you will trade and the brokerage firm you work with.
In standard types of forex accounts, the spread usually constitutes the only transaction cost, making cost calculation in the forex market relatively simple and understandable. However, in account types called ECN - Electronic Communication Network, commission is also used in the transaction cost, and ECN forex commission rates vary between products.
Since low spreads mean lower transaction costs for investors, investors generally prefer institutions with more competitive spread rates. However, spread should not be the only criterion to be considered when choosing a forex brokerage firm.
There are generally two different types of Forex products: variable spread and fixed spread. Fixed spread is a type of spread that is intended to be kept within a certain range, regardless of market conditions. However, even in the fixed spread type, this range may vary depending on market and liquidity conditions.
Variable (dynamic) spread is a type of spread that can change over time according to market and liquidity conditions and where a specific spread rate is not targeted. Variable spreads may narrow in periods when liquidity in the market increases, and they may widen in periods when liquidity decreases.
How to Calculate Spread?
The spread, which represents the difference between the buying and selling price of a currency pair, is usually expressed in pips, where a pip corresponds to 0.0001 units (such as EUR/USD) or 1 in 10,000 for most currency pairs. However, in some products such as Japanese Yen currency pairs, 1 pip can correspond to 0.01 units.
For example, if the buying quote is 1.07140 and the selling quote is 1.07160 in the EUR/USD parity on the Forex trading platform, the difference of 0.0002 is expressed as 2 pip spread.
So, what does this 2 pip spread mean and what does it mean?
In EUR/USD parity, 1 lot transaction is equal to 100,000 base currency units. Since the base currency (primary) in the parity is Euro, the position size of a 1-lot transaction is 100,000 Euros (position size is calculated in base currency).
On the other hand, profit/loss or cost calculations are made in the quote currency (secondary), and in the EUR/USD parity, the quote currency is the US dollar.
In this case, for a position size of 100,000 Euros, the 2 pip spread will be 100,000 * 0,0002 = 20 USD.
If the position size is mini lot (0.1 lot), then the spread cost is calculated as 10.000 * 0.0002 = 2 USD.
Based on this, the following simple method can be used to calculate the spread.
1 spread for 1 lot = 10 quote currencies
1 spread for 0.1 lot (mini lot) = 1 quote currency
1 spread for 0.01 lot (micro lot) = 0.1 quote currency
For example, let's assume that the spread in the GBP/USD parity is 3 and we open a transaction of 0.1 lot (10,000 British Pounds). In this case, since 1 spread for 0.1 lots will be 1 USD (counter money), 3 spreads will be 3 USD.
Attention: Position size in Forex is based on base money; Profit/loss and spread cost calculations are always made in quote currency. For example, in the EUR/GBP currency pair, the position size is in Euros; The spread is calculated in Sterling. However, it is possible to convert these values calculated on trading platforms into dollars or another currency.
On the Forex trading platform, the buying price may appear higher than the selling price. The reason for this is that the purchase price essentially represents the other selling offer; The selling price represents the other buying offer.
Since the spread in the Forex market is the most important concept in calculating the transaction cost, there are a few points to consider in this regard:
The variable spread may change constantly depending on market conditions and liquidity. Spreads can widen, especially when volatility is high and liquidity is low.
Volatility may tend to increase especially before and after important calendar data. Therefore, before making a transaction, it should be known whether there is a news flow with a high potential to affect the market.
In products with fixed spreads, the aim is to keep the difference between the buying and selling quotes within a certain range, regardless of market conditions. However, even in these products, volatility and liquidity conditions may affect spread rates.
The spread may be different for each currency pair. Spreads are generally lower on some major currency pairs (such as EUR/USD, USD/JPY), but spreads may be higher on exotic pairs. Therefore, spread rates should be evaluated separately according to the parity to be traded.
Spread rates also vary between ECN and standard account types. On the other hand, ECN accounts also include commissions, unlike the standard account type.
Apart from the spread, if the traded position is moved at night, there may be swap income or costs depending on the transaction (buying and selling) and product type. Therefore, this issue should also be taken into consideration.
Conclusion
In its simplest form, the term spread in the forex market refers to the difference between the buying and selling quote and is calculated by subtracting the buying price from the selling price. In Forex transactions, multiplying the selling and buying price difference (spread) by the position size gives the transaction cost of the transaction in the opposite currency.
Spreads may also vary between brokerage firms. It is important to choose a broker that offers competitive spreads to minimize trading costs. However, when choosing a brokerage firm, instead of focusing only on spreads, it is also important to check the authorization/license status, examine the stability of the trading platform, and evaluate factors such as the analysis offered by the institution and the adequacy of customer service support.
