What does the Spread Mean in Forex Trading?

Since spread has the most direct relationship with the profit and loss of forex trading, it has become one of the most concerned issues for investors in forex trading. As a trader, you must know the fact that spreads in different platforms are also diverse, and there are also fixed spread and floating spread offered by brokers as well as low&high spread. So what's the normal spread？ And what role does spread play in forex trading？ when will the spread widen？

What is a Spread in Forex Trading？

Every market has a spread and so does forex. A spread is simply defined as the price difference between where a trader may buy or sell an underlying asset such as the currency pairs. Traders that are familiar with the currency pairs involved spread- the Bid: Ask spread.

Below we can see an example of the forex spread being calculated for the EUR/USD. First, we will find the buy/bid price at 1.1400 and then subtract the sell/ask price of 1.1402 What we are left with after this process is a reading of 0.0002.

Traders should remember that the pip value is then identified on the EUR/USD as the 4th digit after the decimal, making the final spread calculated as 2 pips/points.

How Much is the Average Forex Spread？

In general, more active and larger markets offer lower spreads, e.g. the spread of EUR/USD is lower than the spread of other non-major currencies. On the other hand, the smaller the market and the smaller the currency in circulation, the bigger the spread will be. Level of the spread provided by broker is an important factor that affects whether traders choose the broker or not.

Trading mode on forex platforms can be divided into STP(Straight-Through Processing) mode and MM(Market Maker) mode. Different modes have different average spreads.

1. Average Spread Under STP Mode

Under STP mode, the platform does not participate in the transaction of investors, and all orders are sent. The main profit source of the platform comes from the investor's spread, so the spread is relatively high under normal circumstances, and the operation cost is very low. Because it is the bank joint quotation, so the floating point spread is adopted. The average per standard hand spread of EUR / USD is 2 pips.

2. Average Spread Under MM Mode

In MM mode, investors and the platform make bets. The orders of investors are absorbed by the platform. The loss of investors is the source of profits of the platform. Under this mode, the spread will be lower. The average per standard hand spread of EUR / USD is 1pips.

3. Average Spread Under ECN Mode

The spreads on ECN trading platforms are generally very low but are all floating. Brokers who use the ECN model will typically charge a fixed commission on trade entries. As ECN brokers feature spreads as low as zero pip, instead of widening the spread, brokers will usually charge a flat fee as their only source of income.

What's the Types of Spread？

In today's forex market, there are many kinds of platforms. But in the final analysis, there are only two kinds of spread, one is floating spread, the other is fixed spread. What is the difference between floating spread and fixed spread？ Which is better？ What is the difference between floating spread and fixed spread？

Floating spread is generally STP mode, that is to say, traders place orders directly with banks. Fixed spread is generally MM mode, that is to say, traders is directly gambling with platform providers, with great risk.

How Wide the Spread Could Be？

A wide spread means there is a large difference between the bid and the ask price. Emerging market currency pairs generally have a wide spread compared to major currency pairs.

A wider than normal spread generally indicates one of two things, high volatility in the market or low liquidity due to out-of-hours trading. Before news events, or during big shock (Brexit, US Elections), spreads can widen greatly.

Let's take the Brexit as an example, to see how wider the spread can be.

GBP & EUR pairs were the most affected Pairs via Brexit. Through which market were Up & Down and due to high volatility Forex traders were highly impacted. The BREXIT vote was a massive surprise and its impact on forex markets and global markets will last for a long time.

Let's recall What “BREXIT” Vote Looked Like On The 5 Minute Charts

you can notice on the 5 minute chart above that the market moved from around 1.4900 to 1.3400 in around 4 hours. That is a staggering 1500 pips! That took out the ENTIRE year's trading range high to low! It also went to 1985 lows! A 10% drop in the currency in only a few hours.

Why&How does Currency Pairs Widen/Tighten Spread？

It is important to understand which currency pairs have the lowest (best) spread when trading. Although the price difference of major currency pairs and even some cross currency pairs is relatively low, some foreign currency pairs will have a wide spread. As soon as you enter the transaction, you will have a large loss.

The currency pair with the lowest spread is the currency pair with the largest trading volume. The major currency pairs we are looking at are: EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CAD, NZD/USD.

These currencies have the lowest spread against the general price, among which EUR/USD, USD/JPY, GBP/USD are the lowest.

One of the advantages of trading on a higher time frame is that the bid ask spread becomes less important when trading on a higher time frame than trading on a lower time frame. However, even in a higher time frame, some illiquid currency pairs may still have large price differences, which should be considered before trading.

Trading Spread in Sydney/Tokyo/London/New York session

Because of different trading periods, the bid ask spread of a currency pair may vary. In London and New York, most bid ask spreads are at their lowest levels, because they have the largest trading volume.

However, after the end of the New York session and before the start of the Tokyo session, there is a three hour window, during which the price difference may be large. For some cross currency pairs and foreign currency pairs, this situation is more prominent, but the main currency pairs can not be immune.

Although the opening time of the Sydney session is close to that of the New York session, the liquidity is not as good as that of the New York session, so the price difference is large. It was not until Tokyo, three hours later, that trading volume increased and most spreads began to return to normal levels.

How to Use Forex Spread Indicator？

A forex spread strategy can also be strengthened by the use of a trading indicator. The forex spread indicator is typically displayed as a curve on a graph to show the direction of the spread as it relates to bid and ask price. This helps visualise the spread in the forex pair over time, with the most liquid pairs having tighter spreads and the more exotic paiirs having wider spreads.

There will also be a lower spread for currency pairs traded in high volumes, such as the major pairs containing the USD. These pairs have higher liquidity but can still be at risk of widening spreads if there is economic volatility.

MT4 Spread Indicator

MetaTrader platform (both MT4 and MT5) can show you the spread for its pairs and instruments in the Market Watch panel. This is an option that should be enabled manually.

To enable the spread display in Market Watch, right-click the header and tick the Spread entry in the menu.

The result is the following, where you can see the spread in pipettes in the last column:

Spread Indicator for MT4 and MT5

In many cases it is easier to watch the spread directly on the chart and expressed in pips. For this purpose, you can use the MQL4TA Spread Indicator for MetaTrader presented below.

The spread indicator works on MT4 and MT5. The spread indicator has the following features:

* Spread in pips in a minimal window.

* Details about the current instrument in an extended window.

* Spread value in your account currency, given a default position size.

* Alert via email, mobile app or on screen when the spread goes above or below a set value.

The minimal window is very basic and only shows the spread in pips:

The extended window includes also details about the trading asset: