What is a Spread? Spread has various meaning in the financial industry and different markets. The difference between the purchase and sale prices of financial products such as exchange rate and securities is called a spread. The difference between the bid and ask prices are indicated in pips. Pip is the smallest unit that measures the price movements in the pairs and the shorter version for the price interest point. In many parities, it is measured by observing the change in the 4th digit after 0. You will also encounter the spread while performing buying and selling transactions in banks and exchange offices. Spread rates here are much higher than in the forex market.
What Is Spread in the Forex Market?
In the Forex market, the spread is the difference between the bid and ask price on a pair. Since there is no commission in Forex, the spread is paid as a transaction fee. So the difference between buying and selling is the transaction fee. The spread rate varies among parities and brokerage firms. The liquidity status of the financial instrument is also effective in these changes. If the liquidity is high, the spread rate tends to decrease, if the liquidity is low, the spread rate tends to increase.
Since there is a spread in the transactions, when you open a position, you start with a loss equal to the spread amount. In this case, the selling price must exceed your purchase price in order to make a profit.
What are the Spread Types?
When we look at the spreads, we see that there are 2 types; fixed spread and dynamic spread.
What is a fixed spread?
The fixed spread is called the spread that stays at certain intervals without being affected by fluctuations and changes in the market. It is not affected by the rise or fall of liquidity in the product.
What is a dynamic spread?
Dynamic spread is a type of spread that can change in case of fluctuations in the market and changes in conditions. It may decrease when liquidity is rising, and it may increase when liquidity decreases.
We said that the spread rate varies from parity to parity. If we take a look at what the spread is and its importance, it would be more useful to go through an example. Let’s look at the USDEUR parity and find out how much spread we pay in a 1-lot transaction.
The selling price of USDEUR is 1.2192, while the buying price is at the level of 1.2184. In this case, what is the spread rate for 1 unit?
1.2192 – 1.2184 = 0.0008 so 8 pips.
Considering that we are trading 1 lot in USDEUR parity; (1 lot = 100,000 units)
1.2192 X 100,000 = 121,920 USD worth of transactions. In this case, what will be your spread cost?
(1.2184 – 1.2192) X 100,000 = – You will pay $80 spread fee, and you will start with $80 minus.
What Should Be Considered When Looking At Spread Rates?
Spread is a cost you have to pay in whatever financial product you trade, whenever you trade. For this, you should make sure that your profit is above the spread fee after opening a position. Otherwise, you may damage.
If the market is not liquid, you can choose to use a fixed spread instead of a dynamic spread, as the spread rates will be high. In addition, it is very important to know the instrument you will trade well and to learn the volume of the transaction in order to predict the changes that may occur in the spread rates.
Since the spread rates differ from product to product, it is important that you know the spread rates well on which product you will be trading in so that you do not suffer losses.
SEE ALSO: What is a Lot in Forex?