The bid-ask spread is one of the crucial components of forex trading. The bid-ask spread (also referred to as buy-sell spread) is the difference between the sell and the buy price of a currency. It's a synonym to spread, used interchangeably with it. In other words, the spread is the difference between the best (highest) purchase and the best (lowest) sell price on the market. Spreads are important when calculating the trading fees of a forex position.
- The bid-ask spread is the difference between the sell price and the buy price of an asset
- Tight spreads indicate high liquidiy, while wide spreads are a sign of low liquidity and/or high volatility
- The bid-ask spread is one of the main sources of income for brokers
How is spread used in forex?
As described above, the bid-ask spread is the difference between the buy (bid) price and sell (ask) price. For example, if the market price of an asset is $40, the bid price might be $41 and the ask price $39. This makes the spread $2.
In forex trading, the bid is the price at which you can sell the base currency and the ask is the price at which you can buy the base currency.
When you open a forex position through your broker, you will have to pay a transaction cost (trading fee) and this is where spreads come into the picture. Forex brokers work with one of the following two fee settings:
- They pass on the market spread to their clients and add their own commissions/markups
- They provide their own spread, which includes their fees
Some brokers use the bid-ask spread for most financial assets they offer their clients. They use the market bid and ask price and don't incorporate their fees into the spreads. In return, they apply commissions. This method is considered more transparent.
What does a large spread mean?
When the spread is large or wide, there is a big difference between the bid price and the ask price. Illiquid assets i.e. stocks or currency pairs where demand is low, typically trade with wide spreads. Liquid assets, on the other hand, usually have low or narrow spreads.
For example, currencies traded under normal market conditions normally have very tight spreads of 0.0x%, while the spread on penny stocks can be a fraction of a percentage point. In other words, the size of the spread is strongly tied to market liquidity and demand for a particular product. If a lot of people want to trade a certain asset, the spread will be narrow.
How is spread measured in forex?
In forex trading, the spread is usually measured in pips, which is the smallest unit of the price movement of a currency pair. One pip is equal to 0.0001 unit for most currency pairs, except the ones containing JPY where one pip is 0.01. For example, a 1 pip spread for EUR/USD would be 1.1041/1.1042.
Is a high bid/ask spread good in forex?
The bid-ask spread for a currency pair is the difference in the price that someone is willing to pay (the bid or buy) and where someone is willing to sell (the offer or ask). A high or tighter spread indicates greater liquidity, meaning that demand and supply for the given currency pair is ample. When a bid-ask spread is high/wide, the market for the particular currency pair is less liquid or the pair is more volatile.
Who pays the bid-ask spread?
In forex, you will be paying the ask price for the currency you're buying, and you'll receive the bid price for the currency you are selling. In a long EUR/USD trade, you will be paying the ask price for the EUR and you will sell the USD at the bid price. The spread is the difference between the bid and ask price and your broker will keep it as a profit. Think of the bid-ask spread as your transaction cost.
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