In forex trading, the spread refers to the difference between the bid (sell) price and the ask (buy) price of a currency pair. In a currency pair, there are always two prices listed, the bid and the ask. When you sell the base currency, the bid price is what you can sell it for, and when you buy it, the ask price is what you can pay for it.

In a currency pair, the base currency is shown on the left, and the variable, the quote or counter currency, on the right. Pairings let you know how much variable currency is equivalent to one unit of base currency. There is always a difference between the buy and sell price quoted, with the underlying market value somewhere in between.

There are no commissions on the majority of forex currency pairs, but the spread may be charged on all trades you make. All leveraged trading providers will charge a spread rather than a commission, because they factor in a higher ask price compared to the bid price when placing a trade. Depending on what currency pair you are trading, how volatile it is, and what size trade you place, the spread can be different.

Some of the major forex pairs incorporate:

• USD/CHF: US dollar & Swiss franc
• EUR/USD: Euro & US dollar
• GBP/USD: British pound & US dollar
• USD/JPY: US dollar & Japanese yen

How the Spread Is Calculated in Forex

Let’s take a look at how we can calculate the spread on currencies now that we know how they are quoted in the market. There is always a bid and ask price in an forex quote, just as there is in equity markets.

In exchange for the counter currency (CAD), the bid represents the number of dollars the forex market maker or broker is willing to buy the base currency (USD, for example). For instance, the bid price is the amount at which the lender is willing to acquire a foreign currency from a third party.

Brokers and dealers bid and ask for different prices for the same currency. The broker would quote the bid price if a customer initiated a sell trade. An ask price would be quoted by the customer if he wants to execute a buy trade.

An investor in the United States may decide to go long, or buy euros, and the broker’s website shows a bid-ask price of $1.1200/1.1250. An investor would get charged the ask price of $1.1250 if he/she initiated a buy trade. The investor would get the bid price of $1.11200 per euro (assuming exchange rates have not fluctuated) if they sold back the euros to the broker at the time of unwinding their position. Thus, the exchange rate’s bid-ask spread with the broker caused the investor to lose $.0050 on the speculative trade

In order to calculate the spread, the price quote should contain the last large number of the buy and sell price. The spread is paid upfront when you trade forex, or any other asset, through a CFD trading or spread betting account. In contrast, a commission is paid to enter a trade, and another is paid to exit a trade when trading shares. You get better value as a trader when the spread is tight.

For instance:

For the GBP/USD currency pair, the bid price is 1.26739 and ask price is 1.26749

Subtracting 1.26739 from 1.26749 equals 0.0001

Spreads are based on the last large number in a price quote, so 1.0 is considered a spread. Practice trading the forex market risk-free with a demo account, using virtual funds.

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What determines the spread in forex?

Forex spreads can be influenced by market volatility, which can cause fluctuations. Currency pairs can strengthen or weaken based on major economic indicators, for example, therefore affecting the spread. Volatility can cause currency pairs to gap, or they can become less liquid, so the spread will widen.

We recommend keeping an eye on our FX economic calendar to help prepare for possible increases in spreads. You can make a prediction of whether the volatility of a currency pair will increase, and thus whether you might see a larger spread, if you are aware of the events that might lead to reduced liquidity. It can be challenging to prepare for breaking news and unexpected economic data, however.

Forex spread changes

In the event that the forex spread widens dramatically, you may receive a margin call, and worst case, you might be liquidated. When your margin level drops below 100 percent of your account value, you will receive a margin call notification, which means you will not be able to cover the trading requirements. Your positions may be liquidated if you fall below 50% of the margin level.

Therefore, it is crucial to determine how much leverage you’re using and how big your positions are. In forex, smaller amount trades are usually made than in shares, so keeping an eye on your account balance is important.

Final words

Forex spreads are the differences between the bid and ask prices of a currency pair, and are usually measured in pips. When trading forex, it is crucial to understand the factors that affect the spread. In general, major currencies have a smaller spread than exotic currencies, since they are traded in higher volumes.