What is the spread in forex and how do you calculate it?

spread in forex

Putting your money into the forex markets means swapping one type of money for another at an agreed-upon rate. It is why currencies are priced relative to one another. The term “forex spread” refers to the gap between the price a forex broker is willing to purchase a currency and the price at which they’re ready to sell it.

The forex market is bustling, with daily transactions exceeding $5 trillion. It’s a playground for individual traders and forex brokers, hedge funds, national banks, and governments. All these participants’ buying and selling influence how much currencies are worth, how their prices change, and the size of the forex spread.

What is the spread in Forex?

In forex trading, the spread is a minor fee embedded in the bid (buy) and ask (sell) prices of every trade involving currency pairs. When you check the quoted price for a currency pair, you’ll notice a discrepancy between the buying and selling prices that difference is known as the spread or the bid/ask spread.

The fluctuations in the spread are tracked by tiny movements in price known as pips any shift in the currency pair’s fourth decimal point (or the second decimal point for pairs involving JPY). But it’s not just the spread that influences the total cost of your trade; the lot size plays a significant role too.

In every forex transaction, one currency pair is purchased while another is sold. The currency listed first is the base currency, and the second one is the quote currency. In FX trading, the bid price refers to what it costs to buy the base currency, whereas the asking price is what it costs to sell it

Our platform allows you to engage in forex trading around the clock using derivatives like spread bets and Contracts for Difference (CFDs). These financial instruments let you bet on forex price movements without actually owning the underlying currency. 

You have the option to go long (betting on a price increase) or short (betting on a price decrease). Additionally, you can start trading with just a small initial deposit – known as margin.

The required margin for a forex trade is typically just 3.33% of the trade’s total value, enabling you to leverage your investment for greater market exposure while only putting down a fraction of the trade’s value upfront. 

However, it’s important to remember that while using margin can increase potential profits, it can also exacerbate losses.

spread in forex

How to Calculate Spread in Forex Trading?

To figure out the spread in forex, you need to find the difference between the buying and selling prices, measured in pips. This is done by taking the asking price and subtracting the bid price. For instance, if the GBP/USD is quoted at 1.3089/1.3091, you calculate the spread by doing 1.3091 minus 1.3089, resulting in 0.0002, or 2 pips.

Spreads can be either wide (large) or narrow (small) – the greater the number of pips from your calculation, the larger the spread. Traders typically prefer narrower spreads because it makes the trade cost less.

The size of the spread can also be influenced by market conditions such as volatility and liquidity. For instance, widely traded currency pairs like the EUR/USD tend to have narrower spreads compared to less commonly traded pairs like the USD/ZAR. 

However, factors like market volatility and liquidity can cause spreads to widen or narrow.

How Currencies Are Quoted?

In forex trading, currency pairs are the norm, like the pairing of the U.S. dollar and the Canadian dollar (USD/CAD). Here, the first currency listed (USD) is known as the base currency, and the second currency listed (CAD) is referred to as the counter or quote currency (base/quote).

Take, for instance, if you need 1.2500 Canadian dollars to purchase 1 U.S. dollar, this would be represented as USD/CAD at a rate of 1.2500. In this scenario, the USD is the base currency, meaning the rate shows how much of the quote or counter currency (CAD) is needed to buy one unit of the base currency (USD), or in simpler terms, 1.25 Canadian dollars are required to buy one U.S. dollar.

Conversely, for some currency pairs, the USD acts as the quote currency. An example of this is the exchange rate between the British pound and the U.S. dollar (GBP/USD) at 1.2800. This rate means it takes 1.2800 U.S. dollars to buy one British pound, making the pound the base currency in this pair.

How Forex Spreads Are Quoted?

Here’s how a forex broker’s quote for the EUR/USD currency pair might look, including the bid-ask spread:

BidAsk
$1.1200$1.1250
Sell Buy

*EUR/USD Bid-Ask Prices Example

The gap between the buying and selling prices, known as the spread, can be tight or broad depending on the currency pair in question. For instance, a 50 pip spread for EUR/USD, as seen in this example, is quite wide and unusual. 

Normally, the spread would range from one to five pips. Yet, it’s important to note that spreads are flexible and can shift suddenly due to market dynamics.

Investors should keep an eye on the spread charged by their broker because any profitable trade must generate enough to not only cover this spread but also any additional fees. Moreover, brokers may mark up their spreads, which enhances their earnings on each trade.

Now, people may have a common question what is a good spread in forex the best answer is a good spread starts between zero to five pips, benefitting both the broker and the trader.

Essentially, a larger bid-ask spread implies that buyers will pay more and sellers will get less, signifying that the spread each forex broker imposes can significantly affect the overall transaction costs in forex trading.

Conclusion

The forex spread represents the main expense in a currency transaction, embedded in the bid (buy) and ask (sell) prices of a currency pair. This spread is quantified in pips, indicating a change at the fourth decimal point for most currency pairs’ rates (or at the second decimal point for pairs quoted in JPY). To figure out the forex spread, you deduct the bid price from the ask price.

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