When we talk about Forex trading, we refer to the exchange of one foreign currency for another, and the profit that can be made from the different value of such currencies. Other common names are FX or currency exchange.
Whoever has traveled or had done business abroad, knows that exchanging currency is a rather common activity, necessary for daily tasks. However, in the Forex market, it’s possible to exchange currency with the sole purpose of increasing one’s wealth.
The Forex market is the largest and more liquid, with working hours that extend way beyond the share market. It’s been calculated that more than 5 trillion dollars are dealt with in the forex market daily.
When we talk about Forex, there is the word “spread” everywhere. But what are spreads? Why are they important for traders? And how to choose the forex broker with lowest spread?
These famous spreads are a particularity of the forex trading world, and we are going to walk newer traders through what forex trading is and how to deal with spreads.
Forex trading: a quick overview
Forex, as we have mentioned, is the exchange of foreign currencies. They always come in pairs, and there are different types, depending on how popular and common the currencies are.
Many forex brokers advertise the fact that they do not charge commissions. However, do not be fooled by a marketing strategy. Many do no ask for commissions as such, but when it comes to forex trading, there are the famous spreads, which in a way is the money that goes to the broker from your transactions in the currency exchange market.
After that particular point, the forex market is very much like any other market, ruled by the laws of supply and demand.
How do spreads work in forex trading?
When we talk about spreads in forex trading, we refer to the difference between the buying price of a particular currency and the bid price. The asking price is always higher than the bid price, as can be seen in any currency exchange house around the world.
As a rule, the bigger the currency (for example, dollars or euros), the lower the spread.
Different types of accounts also deal with different spreads, so basically the smaller the account, the highest the spread will be for the broker to make a profit.
Another way to put it, it’s to say the spread is the commission the broker gets on the transactions a trader makes in the forex market. So, the lower the spread, the less money is paid in commission, and the more profit is made.
Spreads are calculated in a way that takes into consideration different aspects of your transaction. It depends on how much you are exchanging and what currencies.
It is common to call it “pips” so for example, 0,00006, it’s usually referred to as 0.6 pips. It’s an easier way to express it.
There are also different kinds of spreads, some are fixed, meaning their value doesn’t change, while others are variable. Fixed spreads will be always higher, but imply less risk, while variables may be at some points tempting if traders can deal with the risk involved.
Why do spreads change in forex trading?
Different factors can affect spreads and their high or low value. The obvious first aspect is the activity of traders in the market. If a lot of people are trading in a certain currency, then that one will have a lower spread.
However, during periods of uncertainty, political change, or fear, traders may be more cautious and the movement will be slower, producing a higher spread.
