What is Spread in Forex Trading?

Any buyer is always looking for the best price for the product and services, while the sellers want the highest price possible.  Prices are incentives for sellers and for buyers, as sellers expect to earn a profit for supplying and buyers anticipate saving some money buying at the lowest price. The forex market is no different in this regard as it has the benefits of competitive bidding which is supply and demand. Due to the multitude of offers on the exchange, there are spread quotes for an asset, so the difference between the ask (sell) and the bid (buy) price is called Spread. The Spread is formed by the ratio of order volumes, that is, the ratio of supply and demand.

In forex trading, currencies are always quoted in pairs, so a trading quote is represented by two currency symbols (or ISO codes) that are displayed on the chart - Market depth. All requests that have a pending status and will be executed soon are seen there. Generally, a bid is somewhat lower than an asking price. 

So, the Market depth (aka depth of market or DOM)  goes from the highest price of the asset being sold to the lowest. There is always a better option for both sell and buy and the difference between the two is the bid-ask Spread.

Thus, in Forex and other financial markets, the Spread represents two prices: the buy (bid) price and the sell (ask) price of an asset. Furthermore, whether it is the stock, forex, futures, or options market, every market has these two prices. The bid price represents the maximum price that a buyer is willing to pay for an asset. The asking price represents the minimum price that a seller is willing to take for that same asset. A trade or transaction occurs when a buyer in the market is willing to pay the best offer (ask) or is willing to sell at the highest bid.

Let's take an example where a trader is trading in a stock market and wants to buy one hundred shares of a particular company. 

The first step that is done is a request, which introduces the price that is ready to pay for a share, let it be $90. In case of no better offer, the best price becomes "bid". Meanwhile, the seller wants to get $100 for the same share, and this is the lowest price on the market, that is called "ask". Only in FX trading, the value is expressed in relation to another currency in pips.

Types and Factors Affecting Spread

There are two types of Spreads:

• Fixed
• Variable (also known as "floating")

The trading session, liquidity, and volatility have bearing on the floating Spread. Consequently, can drastically increase during trading news, holidays, and high volatility. The main difference between fixed and floating Spreads is that a fixed Spread remains unchanged even during high volatility, while a floating Spread fluctuates in a range. Fixed Spread is a broker's set income from any of your trades, whereas floating Spread is a broker's volatile income from each of your trades. It can be minimal during quiet trading and can rise sharply during market turbulence.

What determines the spread? Several key factors influence its value.

1. Liquidity of the trading instrument. An asset’s liquidity is also a key factor in determining the spread that a trading platform or broker provides. Tighter spreads are a sign of greater liquidity, while wider bid-ask spreads occur in less liquid or highly-volatile assets.
2. The amount of the transaction. Insignificant or too large volumes of transactions entail additional brokerage costs, which leads to the spread increase.
3. Market condition. Events from all corners of the globe can have an immediate effect on exchange rates and currency values due to the global interconnectedness of the forex marketplace. Political and economic events can drastically affect the situation of the exchange. In anticipation of the release of financial news, the spread grows. An example of a situation that might cause forex dealing spreads to widen would be around the outcome of a pending political election or a national referendum.

How to Deal with the Spread

There is Spread in any Depth Market of various trading instruments. The ability to set large stop losses (SL) and take profits (TP) reduces its importance to a minimum. The case is similar when trading on daily charts. But in day trading, the spread cannot be ignored.

Traders who prefer long-term trading are advised to use a floating spread. Its low value is a good moment for a trader to enter the market. For medium-term time frames, the time of the least volatility is of interest - the spread will remain in the minimum range.

When dealing in the foreign exchange market, the trader should always take into account that the purchase price is slightly higher than that displayed on the chart. When a signal occurs, the point of reference is not it, but the moment of purchase, therefore, when placing take profits, the take profit itself and the spread should be added to the moment of the signal. For one of the most traded EUR/USD pairs, the difference in prices is minimal, and the spread can be neglected without consequences. When buying a less liquid currency, compliance with these conditions is mandatory. The stop loss size is always calculated based on the entry point.

When carrying out sales orders, stop-losses are included in the work a little earlier than the price reaches this level. SL is used to avoid more losses when the trend goes against the trade decision by automatically exiting the trade at a threshold point. The reason for this is that the ask price is slightly higher than the market price. In this case, there is a high risk that the stop loss will work at the time of the sale due to the spread. To avoid this, setting a stop loss at a higher level will help: its value and spread are summed up, then one or two points are added, depending on the specific currency pair. Take profit when selling is set below the market price level.