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What Does a Spread Tell Traders?

By , Forex Trading Instructor
10 January 2014 04:00 GMT

Talking Points

  • Spreads are based off the Buy and Sell price of a currency pair.
  • Costs are based off of spreads and lot size.
  • Spreads are variable and should be referenced from your trading software.

Every market has a spread and so does Forex. It is imperative that new Forex traders become familiar with spreads as this is the primary cost of trading between currencies.

Today we will review the basics of reading a spread and what the spread tells us in regards to the costs of our transaction.

Spreads and Forex

Every market has a spread and so does Forex. A spread is simply defined as the price difference between where a trader may purchase or sell an underlying asset. Traders that are familiar with equities will synonymously call this the Bid: Ask spread.

Below we can see an example of the spread being calculated for the EURUSD. First we will find the buy price at 1.35640 and then subtract the sell price of 1.32626. What we are left with after this process is a reading of .00014. Traders should remember that the pip value is then identified on the EURUSD as the 4th digit after the decimal, making the final spread calculated as 1.4 pips.

Now we know how to calculate the spread in pips, let’s look at the actual cost incurred by traders.

What_Does_a_Spread_Tell_Traders_body_Picture_2.png, What Does a Spread Tell Traders?

Spreads Costs and Calculations

Since the spread is just a number, we now need to know how to relate the spread into Dollars and Cents. The good news is if you can find the spread, finding this figure is very mathematically straight forward once you have identified pip cost and the number of lots you are trading.

Using the quotes above, we know we can currently buy the EURUSD at 1.3564 and close the transaction at a sell price of 1.35474.That means as soon as our trade is open, a trader would incur 1.4 pips of spread. To find the total cost, we will now need to multiply this value by pip cost while considering the total amount of lots traded. When trading a 10k EURUSD lot with a $1 pip cost, you would incur a total cost of $1.40 on this transaction.

Remember, pip cost is exponential. This means you will need to multiply this value based off of the number of lots you are trading. As the size of your positions increase, so will the cost incurred from the spread.

What_Does_a_Spread_Tell_Traders_body_Picture_1.png, What Does a Spread Tell Traders?

Changes in the Spread

It is important to remember that spreads are variable meaning they will not always remain the same and will change sporadically. These changes are based off of liquidity, which may differ based off of market conditions and upcoming economic data. To reference current spread rates, always reference your trading platform. However, to help you get an idea of past average spreads for pairs traded at FXCM, see the referenced hyperlink HERE.

---Written by Walker England, Trading Instructor

To contact Walker, email wengland@fxcm.com. Follow me on Twitter at @WEnglandFX.

To be added to Walker’s e-mail distribution list, CLICK HERE and enter in your email information.

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10 January 2014 04:00 GMT