Used in the Forex market, the spread is a term that is often misunderstood by beginners so in this article we’ll take a closer look at it.
When you trade in the Forex or any other markets, you do so using a trading platform. Also known as a broker, the company is basically a middlemen between you and the market and charge a fee for their services. In the Forex market, this fee is called the ‘spread’ and is the difference between the bidding price and the asking price for every trade you make on this platform and for every currency pair. To know more about the Forex market in general and how to trade it, check out this article.
Why A Spread
In the Forex market, the broker’s position involves some degree of risk. For example, the broker accepts a bid at a certain price but the currency’s value has increased before he managed to find a seller. In this case, since he is still responsible for filling the accepted bid, he may have to accept a sell order that is higher than the buy order he has committed to filling. As a result of accepting the risk of a loss, the broker holds a part of the trade. This part is called the spread.
Let’s use the most common pair in the Forex market as an example, the EUR/USD which is the cross between the Euro and the U.S. Dollar. At the time of writing the EUR/USD is at 1.1555. If you think that the Euro has showed strenght recently against the Dollar, you believe that the price will go up and so you buy at the asking price. But the asking price won’t be exactly 1.1555, it will be a bit more like 1.1557, which is the price you will pay for the trade. The seller, won’t receive the full 1.1555 either. He will get a bit less, let’s say 1.553. This difference of 0.0004 Euro between the bidding price and asking price is the spread. Put like this, it doesn’t sound like much but the Forex is the biggest market in the world. Everyday, more than $5 trillions are being traded there and the biggest investment banks and hedge funds participate actively in this market. Therefore, the average trade can be really large and this makes it really profitable for brokers.