June 14, 2022 - 10:35 AM 379 views
currency pair, forex brokers will provide you two separate prices: the bid and
The "bid" is the price at which the
base currency can be SOLD.
The "ask" is the price at which the
base currency can be purchased.
is the difference between these two prices.
referred to as the "bid/ask spread."
do not charge commissions rely on the spread to make money.
represents the cost of enabling instantaneous transactions. This is why "transaction cost" and "bid-ask spread" are
The cost of
making a trade is included into the buy and sell price of the currency pair you
want to exchange, rather than being charged separately.
sense from a business aspect. The broker provides a service and must earn a
profit in some way.
by selling the currency to you for a higher price than they purchased for it.
They also profit by purchasing currency from you at a lower price than they would receive when they sell it.
is the term for this discrepancy.
It will need
to buy your iPhone at a lesser price than it would sell it for in order to earn
If it can
sell the iPhone for $500, the maximum it can buy from you is $499 if it wants
to earn any money.
is the $1 difference.
broker says "zero commissions" or "no commission," this is
misleading since you still pay a commission even if there is no separate
It's simply a function of the bid/ask spread!
is commonly expressed in pips, which is the smallest unit of a currency pair's
One pip is
equal to 0.0001 for most currency pairs.
is an example of a two-pip spread for EUR/USD.
The Japanese yen is quoted to just two decimal places (unless there are fractional pips, in which case it is quoted to three decimal places).
USD/JPY, for example, would be 110.00/110.04. This quote shows a 4 pip spread.
Types of Spreads in the Forex Market (FX)
The types of spreads you'll see on a trading platform are determined by the forex broker's business model.
Spreads are divided into two categories:
2-Variable (sometimes known as "floating") is a type of variable that cannot be changed.
Usually, fixed spreads are provided by forex
brokers that functions as a “market maker” or “dealing desk models” whereas the
variable spreads are provided by the forex brokers functioning as a
“non-dealing desk model.”
spreads remain constant no matter what the market conditions are at any one
time. In other words, the spread is unaffected whether the market is erratic
like Kanye's moods or quiet as a mouse. It does not change.
operate on a market maker or "dealing desk" model offer fixed
buys large positions from their liquidity provider(s) and offers them to
traders in smaller sizes through a dealing desk.
that the broker is the counterparty to the trades of their clients.
Because they can control the prices they present to their clients, a forex broker with a dealing desk can offer set spreads.
spreads have lower capital requirements, making it a more affordable option for
traders who don't have a lot of money to start with.
set spreads also simplifies the process of calculating transaction expenses.
Because spreads never fluctuate, you always know how much you'll spend when you open a transaction.
with fixed spreads, requotes are common because pricing comes from a single
source (your broker).
regularly, we mean almost as frequently as the Kardashian sisters' Instagram
There can be
moments when the currency market is extremely volatile, with prices fluctuating
rapidly. Because spreads are fixed, the broker will not be able to modify the
spread to market conditions.
If you try
to enter a deal at a given price, the broker will "block" it and ask
you to accept a different price. A new price will be "re-quoted" to
platform will display a requote notification informing you that the price has
changed and asking if you are willing to accept it. It's almost always a lower
price than the one you requested.
issue is slipping. When prices move quickly, the broker is unable to maintain a
continuous fixed spread, and the ultimate amount you pay after initiating a
transaction will be significantly different from the original entry price.
When you swipe right on Tinder and agree to meet up with that attractive gal or guy for coffee, you'll notice the person in front of you doesn't look anything like the photo.
Variable spreads, as the name implies, are continually changing. The difference between the bid and ask prices of currency pairs is continually shifting with varying spreads.
desk brokers provide variable spreads. Non-dealing desk brokers obtain currency
pair pricing from a variety of liquidity providers and pass these prices on to
traders without the use of a dealing desk.
that they have no influence over the spreads. And spreads will broaden or
narrow depending on currency supply and demand as well as overall market
Typically, spreads expand when economic data is released, as well as other times when market liquidity is low (like during holidays and when the zombie apocalypse begins).
For example, you might want to purchase EURUSD with a 2 pip spread, but just as you're about to press the buy button, the US unemployment report is issued, and the spread quickly widens to 20 pip!
Oh, and spreads may expand if Trump comments about the US dollar while still in office.
aren't an issue with variable spreads. This is because the spread takes into
account price movements due to market conditions.
just because you won't be requoted doesn't rule out the possibility of
Trading forex with variable spreads also gives more transparent pricing, especially when considering that having access to numerous liquidity providers usually equals better pricing due to competition.
Now that you know what a spread is and the two sorts of spreads, there's one more thing you need to know...
relationship between the spread and actual transaction costs.
It's really simple to compute and only requires two items:
1- The price of a pip
2- You're trading a certain quantity of lots.
You can buy
EURUSD at 1.35640 and sell EURUSD at 1.35626 in the above quote.
indicates that if you bought EURUSD and then immediately sold it, you would
lose 1.4 pips.
the cost per pip by the number of lots you're trading to get the overall cost.
trading small lots (10,000 units), the value per pip is $1, hence the cost of
opening this trade is $1.40.
The cost of
a pip is linear. This implies you'll have to multiply the cost per pip by the
number of lots you're dealing with.
increase the size of your position, your transaction cost, which is reflected
in the spread, will also grow.
If the spread is 1.4 pips and you're trading 5 micro lots, your transaction will cost $7.00.
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