What is a spread?
In margin forex trading, there are
two prices for each currency pair, a "bid" (or sell) price and an
"ask" (or buy) price. The bid price is the rate at which traders can
sell to the executing firm, while the ask price is the rate at which traders
can buy from the executing firm.
Bid/Ask
For example, when you see the price
quote of EUR/USD is 1.2881/1.2884 as in the above picture, the bid is 1.2881
whereas the ask is 1.2884. That means traders looking to sell must do so at
1.2881, those looking to buy must do so at 1.2884.
The difference between the bid and
ask price is the spread, which constitutes the cost of the trade. In fact, all
traded instruments - stocks, futures, currencies, bonds, etc. - have spread. If
a trader buys at 1.2884 and then sells immediately, there is a 3-point loss
incurred. The trader will need to wait for the market to move 3 points in
favour of his/her position in order to break even. If the market moves 4 points
in your favour, he/she starts to profit.
Many online trading firms like to
promote margin forex trading as an almost cost-free instrument - commission
free, no service charge, no hidden cost, etc. Traders should know that spread
is the cost of trading, and in fact, it also represents the main source of
revenue for the market maker, i.e. the forex trading company. The spread may
appear to be a minuscule expense, but once you add up the cost of all of the
trades, you will find it can eat away quite a portion of your account or your
profit. If you check the price tag of a T-shirt before you buy it, do the same
thing when you trade forex, look into the spread before you decide to trade.
Your trade needs to surmount the spread (the cost) before it profits.
Know your expense: the spread
Spread is the cost to a trader. On the
other hand, it is a revenue source of the firm who executes the trade. In the
foreign exchange market, the spread can vary a lot depending on the executing
firm and the parties involve. Inter-bank foreign exchange can have spread as
tight as 1-2 pips, while the bank can widen the spread to 30-40 pips when
dealing with individual customers. If you check out the spread of those small
exchange shops nearby the tourists' sights, you may find the spread can go up
to 400 to 600 pips.
Thanks to keen market competition,
the spread of online forex trading is getting tighter in the past few years.
For major online forex companies, their spreads are essentially the same. The
table shows the typical spread of four major currencies of online forex trading
at the time being:
Currency
pairs
|
Spread
|
EUR/USD
|
2-3
pips
|
USD/JPY
|
3-4
pips
|
USD/CHF
|
5
pips
|
GBP/USD
|
5
pips
|
It is important for a trader to find
the tightest spread as possible, but anything that is far lower than the
typical spread is skeptical. The spread is the main source of revenue of a
forex trading firm, if the firm cannot earn enough from the spread, there maybe
some other hidden cost in the transaction.
Another point to note is that many
market makers often widen the spread when market conditions become more
volatile, thus increasing the cost of trading. For instance, if an economic
number comes out that is off expectations, thereby creating a flood of buyers
or sellers, the market maker may often widen the spread to restore the balance
between buyers and sellers. As a result, traders should inquire about the
execution practices of their clearing firm; firms with poor execution of orders
and a tendency to widen spreads will ultimately result in higher trading costs
for the end user.
ForexTrendy is a state of the art application capable of detecting the safest continuation chart patterns. It scans through all the forex pairs, on all time frames and analyzes every potential breakout.
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