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Business : Forex Spreads : The Meaning Of A Spread In The World Of Trading
A Spread in Forex trading is the difference between the Bid and the Ask Price of any given currency pair. The Bid is the price at which you can sell a currency pair and the Ask is the price at which you can buy the pair. This difference in Price is calculated in Pips. In general, a trader is better served with smaller Spreads. While evidently, this explanation of Forex Spreads has necessitated the use of Terms which may be unfamiliar or difficult to understand for a Beginner in Forex trading, i will use the next Paragraphs to explain better.
The Definition of a Quote
A quote is a Shorthand representation of a currency pair that is traded in the Forex market and its accompanying current Price. A quote contains two currencies that are being swapped for each other and also their price information. In Forex trading, currencies are usually quoted with their three letter abbreviations.
An example quote would be EUR/USD = 1.50000/1.50010.
In this example, the three letter abbreviation EUR stands for the Euro and USD stands for the United States Dollar. The currency to the left of the Slash is called the Base currency, while the currency to the right is called the Quote or the Counter currency. This means that the pricing information to the right of the “equals†sign reefers solely to the market price of the base currency, quoted in the quote currency. In this example, EUR has a value of 1 and USD has a value of 1.50000/1.50010. In simple terms, it means that 1 Euro is currently being exchanged for about 1.5 Dollars.
The Bid and Ask
Having covered the currency part of a quote, we will now cover the price part. Continuing with our example from above, the price to the left of the Slash, 1.50000, is the Bid, and the price to its right is the Ask. The Bid is the price at which the market is willing to buy 1 Euro from you. So, in this case, you can Sell your Euro for 1.50000 Dollars. But if you want to buy Euro, the market will Sell 1 Euro to you at the price of 1.50010. This difference in price is called the Spread. Spreads are there so that Market Makers and Brokers can make their own money for the services they render to the trader. Spreads are calculated in Pips.
What is a pip
A pip (percentage in point) is used to calculate the micro differences in price while trading. In Forex, one pip is equivalent to 1/10,000. For example, this means that 100 pips equals 1 cent, and 10,000 pips equal 1 Dollar. All price changes in Forex, including Forex Spreads, are calculated and given in Pips.
Examples of live Quotes with Spreads
-EUR/USD = 1.20200/1.20280. The Spread here is 8 pips
-GBP/USD = 1.90500/1.90900. The Spread here is 40 pips
-USD/CHF = 0.94001/0.95001. The Spread here is 100 pips
More info on Spreads
Widening Spreads indicate dwindling Liquidity in the markets, while tightening Spreads indicate increasing Liquidity. A ranging market with wide Spreads most times, is just waiting for a Breakout. The time period with the tightest Spreads is usually around the beginning of the European trading Session, and is usually full of dramatic market movements, which are indications of increased Liquidity and therefor market participation by traders.