Many beginning currency traders ask what Forex spread is. Despite the common unfamiliarity of this term to the laymen, it is a rather simple concept. Nevertheless, it is also very important in Forex trading as the profits and losses depend on the spreads of the currency pairs.
Definition
Forex spread is a difference between the price you can buy a currency pair from the market (Ask) and the price you can sell a currency pair to the market (Bid). That is why it is often called a Bid/Ask spread. Ask price is always a bit higher than the Bid price, which results in your positions to open with a slight loss, which is of the same size as spread – that is why it is so important to understand the concept of the Forex spread and to seek brokers with the smallest spread possible.
Spread Examples
EUR/USD spread with 4 decimal places in quotes: Ask is 1.4102, Bid is 1.4100, spread is 1.4102 – 1.4100 = 0.0002 or 2 pips.
GBP/JPY spread with 2 decimal places in quotes: Ask is 134.17, bid is 134.11, spread is 134.17 – 134.11 = 0.06 or 6 pips.
EUR/USD spread with 5 decimal places in quotes: Ask is 1.41023, Bid is 1.41004, spread is 1.41023 – 1.41004 = 0.0019 or 19 fractional pips, or 1.9 normal pips.
USD/JPY spread with 3 decimal places in quotes: Ask is 86.782, Bid is 86.770, spread is 86.782 – 86.770 = 0.012 or 12 fractional pips, or 1.2 normal pips.
How to Use Your Knowledge of Forex Spread in Trading?
Considering that when you open a trading position in a Buy direction you do that at an Ask price and when you sell it you do it at a Bid price, you should always keep in mind your spreads when you develop your Forex trading system. For example, your system tells you to use 20 pips
- You can add the TP value to your open level (subtract for the short positions) and subtract the SL from the same level (add for the short positions). This way you preserve the win/loss values and ratio but you increase the probability of your
stop-loss being hit and decrease the probability of yourtake-profit being hit. - Alternatively, in addition to the actions listed above, you can subtract Spread from your TP and SL (add Spread for the short positions). This will preserve the probabilities of the
stop-loss ortake-profit levels being hit but will reduce your profit in case oftake-profit and will increase your loss in case ofstop-loss .
As you see, both techniques have their own disadvantages, so you should watch at your specific system closely to apply your knowledge of the Forex spread correctly when calculating your potential profit/loss.
