Blog Summary: 

Spreads are a key cost in forex trading. They impact your profit margins and reflect market conditions like volatility and liquidity. 

This blog explains what spreads are, how they’re calculated, and what factors influence them. You’ll also find tips to minimize spreads, like trading during peak hours and choosing the right broker, along with the benefits of using simulated accounts to refine your trading skills. 

Get the insights you need to trade smarter and maximize your profits! 

In foreign exchange trading, which is the most common type of currency trading, spread is a type of cost built into the price of every currency trade as a way for brokers to make money.  

Understanding the spread of a given currency pair as a forex trader is important because not only can it affect your profit margin, but it can also put you on margin call, causing the capital in your trading account to dip below the required minimum.  

Let’s uncover more so you can develop a deeper understanding of this essential trading concept and, ultimately, become a master forex trader. 

Why Spread Matters

To brokers, a higher spread can be used to offset unfavorable or volatile market conditions. 

To forex traders, on the other hand, a wider spread means you’re paying more to enter a trade, reducing your potential profit. A tighter spread minimizes your costs, allowing you to keep more of your earnings. 

So, what exactly is spread anyway, and how does it work? It’s the difference between the buy (bid) and sell (ask) price of a currency pair. 

What is Spread & How is it Calculated?

To understand spread, you will first need to know how forex trading works. It’s all based on currency pairs and exchange rates.

The relative strength or value of one currency compared to another one influences the market values of each currency. But ultimately, brokers set the bid and ask prices for forex trades, and as a result, influence the spread. 

All forex trades involve buying one currency pair and selling another. 

How to Calculate Spread Using Forex Bid and Ask Prices

Imagine you want to trade EUR/USD. You see the values of each as follows: EUR: 1.1050 and USD: 1.1053. The lower price (1.1050) is the bid price, or the price at which the exchange will buy Euros from you. The higher price (1.1053) is the ask price, or the price at which they’ll sell you Euros.  

The difference between these two prices, 0.0003, is the spread of this trade.  

Spread is also referred to in “pips”. In this case, the spread would be referred to as 3 pips. As you can see, pips involve changes in the fourth decimal place of a currency pair. When trading pairs quoted in JPY, pips refer to changes in the second decimal place. 

While to brand new forex traders, such small changes in decimal points may seem insignificant, they are not. On the contrary, for most trades, the spread is around 1-5 pips. This is referred to as a “tight” spread. A “wide” spread, by contrast, might be something more like 50 pips. A wider spread usually represents more volatility or risk to the trader. 

Factors That Influence Spread

Now that you understand what spread in forex is and how to calculate it for a given trade, you should understand what factors influence it. The main factors influencing spread are: 

• The Given Currency Pair: Popular currency pairs like EUR/USD tend to have tighter spreads due to high trading volume and more liquidity. Less traded pairs, on the other hand, usually have wider spreads. 
• How Volatile the Market Is: During times of high market volatility or economic uncertainty, spreads can widen significantly, even for more popular currency pairs. 
• Your Broker: Different brokers offer different spreads. 
• Time of Day: Different forex markets open at different times. The time of day can therefore influence how many people are trading given currency pairs, and thus, liquidity. And if you remember, liquidity influences spread.  

What is a “Good” Spread?

Because spread is influenced by a variety of factors, a “good” spread might look different depending on the currency pairs being traded, current market conditions, and more. Most traders aim for spreads of only a few pips, if possible. In some cases, this isn’t possible.  

How to Minimize Spread as a Forex Trader

While there’s a lot you can’t control as a forex trader, there are a number of actions you can take to minimize your trading risk, including these: 

• Choose Your Broker Wisely: Choose a reputable broker known for competitive spreads. 
• Trade During Peak Hours: Liquidity is highest during peak trading hours, leading to tighter spreads. 
• Avoid News Events: Spreads tend to widen around major news releases and events. 

Master Forex Trading with a Simulated Account

The higher the spread of a trade is, the less money you are likely to make. Therefore, it’s important to understand and be able to calculate spread and use this knowledge to make informed, strategic trading decisions.  

This is just one aspect of successful forex trading. Others include successfully interpreting and understanding market dynamics, managing risk, understanding trading psychology, managing emotion, and much more. 

Instead of trying to learn all that in real-time with real money at risk, an increasing number of traders are starting their forex trading journeys with a simulated funding account.  

Simulated accounts let you trade in live conditions in a demo environment. Most offer profit splits. For instance, at Maven Trading, you are entitled to an 80% profit split for your withdrawal. 

Curious to learn more about how a funded account could help you master the art of forex trading while managing risk and protecting your money? Head to our “How it Works” page now for additional information.