- Spreads are calculated based on the price at which a currency pair is bought and sold.
- The cost of a transaction is based on the forex spread and lot size.
- Spreads for forex are subject to change and should be referenced on your trading platform.
FX spreads are a key cost in trading currencies. It is important that traders be aware of them. This article will explain how forex spreads work and show you how to calculate costs. Also, how to monitor changes in spreads to maximize trading success.
What is a spread in FOREX Trading?
Every market has a spread and so does forex. Spread simply refers to the price difference between an underlying asset and where a trader can purchase it or sell it. This spread is commonly known by traders who are familiar with equities.
Below we can see an example of the forex spread being calculated for the EUR/USD. We will first find the buy price at 1.13398, then subtract the sell prices of 1.3404. After this, we get a reading of 0.00006. Remember that traders should keep in mind that the EUR/USD pip value is identified as the fourth digit after decimal. This makes the spread of 0.6 pips.
We now know how to calculate spread in pips. Let's examine the actual cost for traders.
HOW TO CALEALE THE FOREX SPREADS AND COSTS
Remember that spreads are simply the ask price less (minus the bid price) of a currency pair. In our example, 1.13404-1.13398 = 0.06 pips.
We can buy EUR/USD at 1.13404 at the moment and close the transaction at 1.13398. This means that traders would be charged 0.6 pip spread once the trade is closed.
We will need to divide this total spread cost by the pip cost and take into account the total number of lots that were traded. A 10k EUR/USD lot would cost you 0.00006 (0.6pips) times 10,000 (10k lots) = $0.6. Spread costs for a standard lot (100,000. units of currency) would be 0.00006pips (6.6%) X 100,000 (1 standard lots) = $6.
You will need to convert your account to US Dollars if it is in another currency such as GBP.
UNDERSTANDING A HIGH AND LOW SPREAD
It is important to remember that FX spreads can change throughout the day. They can range from a high spread to a low spread.
The spread can be affected by many factors, such as volatility and liquidity. Some currency pairs, such as emerging market currency pairs have a wider spread than major currencies pairs. Major currency pairs trade at higher volumes than emerging market currencies. This leads to lower spreads in normal conditions.
It's also well-known that liquidity can dry up, and spreads can increase in the lead up major news events and between trading session.