What is a spread in forex? 

The spread is the difference between the selling price and the buying price of a particular asset. 

 What is a spread? And what is the bid-offer spread? 

• The “bid” is the price at which you can SELL the base currency.  

• The “ask” is the price at which you can BUY the base currency. 

The selling price is always lower than the buying price. 

For example, if the selling price is 1.2840 and the buying price is 1.2842, the spread is the difference between the two prices: 2 pips. 

The spread is reflected in the position valuation once it is opened. 

The bid-ask spread is just another way of talking about the spread applied to the price of an asset. 

How do markets determine bid and ask prices? 

• The market determines bid and ask prices through the placement of buy and sell orders placed by investors and/or market makers.  

• If the demand for buying exceeds the supply for selling, the stock price will often rise in the short term, although this is not guaranteed.  

• When investors talk about the bid-ask spread, they are often referring to stocks, but the same terminology is used when trading other securities such as options and bonds.  

• In options, the bid versus ask price varies depending on the position of the option. 

Example of a bid-ask spread in stock market: 

For example, suppose an investor wants to buy 1,000 shares of Company A for $100 and has placed a limit order to do so. Suppose another investor places a limit order to sell 1,500 shares for $101. If these two orders represent the highest bid and lowest ask price in the market, the spread on that stock is $1. 

The bid-ask spread can be affected by number of factors: 

• Liquidity. This refers to how easy it is to buy or sell an asset. As the liquidity of an asset increases, the bid-ask spread typically narrows 

• Volume. This is a way of reporting the amount of an asset that is traded each day. Assets with higher trading volume often have narrower bid-ask spreads 

• Volatility. This is a measure of how much a market price changes in a given period. During periods of high volatility, when prices change rapidly, the spread is typically much wider 

Spread Charges break down: 

The spread is one way traders pay to execute a trade. For some assets, such as stocks, providers will not use the spread but will charge a commission basis – other assets may feature a combination of the two. 

When trading products with a spread, the trader hopes that the market price will move beyond the spread price. If this happens, it means that the trade can be closed for a profit. If the price does not move beyond the spread cost, the trader may close the trade at a loss, even if the market moves in the direction he expected. 

What are the types of spreads in the Forex market? 

The type of spreads you see on your trading platform depends on the Forex broker and how they make money from it. 

There are two types of spreads: 

• Fixed 

• Variable (also known as “floating”) 

Spreads and brokers: 

Brokers that operate as a market maker or “dealing desk” model offer fixed spreads, while brokers that operate as a “non-dealing desk” model offer variable spreads. 

The choice between fixed and variable spreads depends on your trading style, risk tolerance, and experience in the market. It is important to understand the characteristics of each type of spread.  

What are fixed spreads in Forex? 

Fixed spreads provide a predictable trading environment. Unlike variable spreads that widen during volatile market conditions, fixed spreads remain constant. This consistency can be beneficial for scalpers and traders who rely on small, frequent profits. 

However, it is important to remember that fixed spreads are offered by brokers operating as market makers. This means that the broker acts as a counterparty to your trades, which can create a conflict of interest. 

Advantages of Trading with Fixed Spreads: 

Fixed spreads provide a degree of certainty in trading costs, making them suitable for traders with smaller accounts or those who prioritize predictable expenses. However, this certainty comes at a cost. 

 Disadvantages of Trading with Fixed Spreads: 

Requote Risk: In volatile markets, fixed spreads can lead to frequent requotes – where the broker adjusts the price before executing your trade. This can lead to unfavorable entry prices or missed trading opportunities. 

Slippage: Rapid price movements can cause the actual execution price to deviate significantly from the intended entry point, potentially impacting your profitability. 

What are variable spreads in Forex? 

As the name suggests, variable spreads are always changing. With variable spreads, the difference between the bid and ask prices of currency pairs is constantly changing. 

Variable spreads are offered by non-dealing brokers. Non-dealing brokers obtain currency pair prices from multiple liquidity providers and pass these prices to the trader without the intervention of a dealing desk. 

This means that they have no control over the spreads. Spreads will widen or narrow based on the supply and demand for currencies and overall market volatility. 

Spreads typically widen during economic releases as well as other periods when market liquidity is low (like during holidays). 

 Advantages of trading with variable spreads 

Less requotes: By dynamically adapting to market conditions, variable spreads reduce the risk of orders being rejected or re-priced due to sudden price fluctuations. 

Increased transparency: Variable spreads provide a more accurate reflection of real-time market conditions, providing greater transparency into the true cost of trading. 

Potentially better pricing: Access to multiple liquidity providers often results in more competitive pricing, which can result in lower overall trading costs. 

 Disadvantages of trading with variable spreads 

Impact on speculation: Speculators, who rely on small price movements to make profits, can be significantly impacted by wide spreads, which can quickly erode their potential gains. 

Challenges for news traders: During major news events, market volatility can cause spreads to widen dramatically. This can quickly turn potentially profitable trades into losing positions. 

Fixed vs. Variable Spreads: Which is Better? 

The question of which option is better between fixed and variable spreads depends on the needs of the trader. 

• There are traders who may find fixed spreads better than using variable spread brokers. The opposite may be true for other traders as well. 

• In general, traders with smaller accounts who trade less frequently will benefit from fixed spread pricing. 

• Traders with larger accounts who trade frequently during peak market hours (when spreads are tighter) will benefit from variable spreads. 

• Traders who want fast trade execution and need to avoid requotes will want to trade variable spreads. 

Spread Costs and Calculations: 

Calculating the spread between yields is essentially the same as calculating the bid-ask spread—simply subtract one yield from the other. For example, if the market rate for a five-year CD is 5% and the rate for a one-year CD is 2%, the spread is the difference between them, or 3%. 

The effective spread measures the true cost of executing a market order by comparing the actual execution price to the theoretical midpoint of the bid-ask spread. This calculation provides a more accurate representation of trading costs, especially in highly liquid markets where the impact of orders on prices is minimal. 

Spreads reflect liquidity: narrow spreads typically indicate high liquidity and low trading costs, while wider spreads indicate the opposite. Furthermore, the term “spread” can also describe a trading strategy where an investor simultaneously sells one futures contract or currency and buys another. This is known as a spread trade. 

Strategies to minimize spread costs: 

• Choose Brokers Wisely by Selecting brokers with tight spreads. 

• Trade Liquid Pairs, Major currency pairs like EUR/USD and GBP/USD generally have tighter spreads cause of high liquidity. 

• Avoid Trading During Volatile Periods. 

• Consider ECN/STP Brokers, these brokers often offer tighter spreads by connecting you directly to the interbank market. 

Mastering Spread Costs: 

By understanding spread costs and implementing strategies to minimize them, you can gain a significant edge in the forex market.  

How is the spread calculated in the Forex market? 

Forex prices are always provided at bid and ask prices, similar to what you see in stock markets. 

Forex spreads are the difference between the bid and ask prices of a currency pair. 

Example: For EUR/USD, the bid price is what you’d receive if selling euros, and the ask price is what you’d pay to buy euros. 

• Bid: 1.1200 

• Ask: 1.1250 

• Spread: 50 pips (1.1250 – 1.1200) 

Spread Dynamics: 

• Variability: Spreads are dynamic and fluctuate based on market conditions, liquidity, and the specific currency pair. 

• Typical spreads range from 1 to 5 pips, but wider spreads can occur during volatile periods or for less liquid currencies. 

• Broker Influence: Brokers contribute to the spread, impacting trading costs. Wider spreads generally mean higher trading expenses. 

Impact on Traders: 

• Trading Costs: Spreads directly impact trading profitability. 

• Price Discrepancy: The spread represents a built-in cost that traders must overcome to generate profits. 

• Broker Comparison: Traders should compare spreads across different brokers to find the most competitive pricing. 

What are Options Spread? 

An options spread is an options strategy that involves buying and selling options with different strike prices and/or expiration dates. 

There are a few different types of options spreads, but we will focus on the vertical spread. A vertical spread is when the two options involved are of the same type, relate to the same underlying asset, and have the same expiration date.  

A vertical spread is created when options contracts are bought and sold simultaneously. They can be organized into two categories: debit and credit. Within these categories, you can buy a bullish spread or a bearish spread. 

Vertical spreads can be categorized into several different categories: 

• Bull Spreads: As the name suggests, you are bullish and hope to profit from a rise in the underlying stock’s price 

• Bear Spreads: As the name suggests, you are bearish and hope to profit from a fall in the underlying stock’s price 

• Debit Spreads: Involves buying an option at a high premium while selling an option at a low premium, which requires you to pay upfront.  

• Credit Spreads: Involves selling an option at a high premium while buying an option at a low premium, which results in a credit to your account.  

The main reason you might consider vertical spreads is simple: you have limited potential for loss. Because you are buying one option and selling another, your overall cost is lower. 

The tradeoff, however, is that your potential for profit is also limited. 

This is also why you might want to consider the spread if you think the stock will only move a little – your profit is limited, but you don’t expect the stock to move much anyway, so that might be all you’re looking for

How Options Spreads Work? 

Let’s say you want to invest in Toastr (TSTR), a maker of smart toasters. Instead of buying the stock outright, you could buy a call option, which is a less expensive investment and could pay off if the stock goes up. 

But what if you want to risk less money on your options contract? You could roll your investment into a spread (specifically, a bull call spread), and sell a different call option on TSTR. Taken together, buying a call option and selling another call would complete the spread, offsetting the cost of the more expensive call option you bought with the call option you sold. 

The maximum loss on a bull call spread is the premium you pay — in this case, the premium of the call option you bought, minus the premium of the call option you sold. 

To calculate the maximum profit you can make from a vertical spread, simply multiply the difference between the strike prices by 100 (remember, options contracts are for 100 shares) and subtract the number you get for your maximum risk (the difference in premiums). So, to sum it up: 

• Maximum Loss = Difference in Premiums 

• Maximum Profit = (Difference in Strike Prices x 100) – (Difference in Premiums) 

At the end, understanding spreads is crucial to navigating the dynamic world of forex trading. By carefully considering your trading style, risk tolerance, and market conditions, you can choose the type of spread that best suits your needs and implement strategies to minimize its impact. 

Remember: control what you can control, by choosing the right broker with the tighter spreads