Understanding the Spread that Traders Should Know

Trading in financial markets, whether Forex, cryptocurrencies, or stocks, all involve one key aspect related to transaction costs: spread, which is the difference between the bid price and the ask price. Understanding this mechanism will help investors plan their profits more intelligently.

What is the spread and what role does it play in trading?

Spread or Spread generally refers to the difference between the (Bid Price) and the (Ask Price) of any asset in the financial market.

When we look at trading platforms, we see two sets of prices. For example, EUR/USD might show a Bid at 1.05672 and an Ask at 1.05680. The difference of 0.8 pips is the spread. If we quickly reverse our position, we will lose money here. The platform provider (broker) will take this spread as a fee for managing the account.

The same concept applies to trading other commodities. For instance, if you buy gold at a certain price, to make a profit, you need to sell at least at a higher price. The difference is the necessary cost.

How does the spread indicate the health of the market?

Measuring the width of the spread helps us assess the liquidity level of the market. Generally, highly competitive Forex markets have a spread of about 0.001%. However, when we observe the spread widening to 1-2%, it indicates that the market has low liquidity at that time. Trading becomes more difficult, and transaction costs increase significantly for traders.

Types of spreads: Fixed and Variable

Traders can choose between two types of spreads, each with different characteristics, advantages, and disadvantages.

$500 Fixed Spread$501

Features: The broker sets the difference between Bid and Ask to remain constant, regardless of market conditions.

Advantages:

• Traders can calculate costs precisely and confidently since the value does not change.
• Convenient for those who want to plan their finances accurately.

Disadvantages:

• Frequent Requote issues, which can hinder order execution until a new price is agreed upon.
• During high volatility, brokers may change the spread rapidly, requiring traders to adjust their plans accordingly.

Variable Spread(

Features: The spread value fluctuates constantly, rising and falling according to supply and demand. Brokers pass market prices directly without interference.

Advantages:

• No Requote problems since prices follow the actual market mechanism.
• During high liquidity periods, spreads are narrower, often resulting in lower costs than Fixed Spreads.
• Suitable for frequent traders.

Disadvantages:

• High uncertainty; when important news is released, spreads can spike from around 2 pips to 20 pips in a split second.
• Not suitable for beginners, as transaction costs can suddenly increase.

Which type is the best choice?

There is no one-size-fits-all answer. Ultimately, the choice depends on your trading style and expertise.

For retail traders: who trade small sizes, Fixed Spreads are more suitable because costs are predictable.

For large traders: who trade frequently and in large volumes, Variable Spreads often offer more benefits. Sometimes they reduce costs and also avoid Requote issues.

Key takeaway: Regardless of the choice, it’s advisable to select popular Forex pairs like EUR/USD or GBP/USD, which typically have fixed and narrower spreads due to high trading volume and liquidity. Less popular pairs tend to have wider and more volatile spreads.

Summary

When traders understand what the spread is and how it functions, they can make more effective trading decisions. The spread is an unavoidable cost but can be managed and controlled through choosing the right broker, spread type, and currency pairs. Forex trading is a financial business that requires knowledge and planning, making it different from gambling. Those with a deep understanding of these mechanisms are more likely to succeed.