Forex Spread

By: EconomyWatch   Date: 28 July 2009

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In the forex market, one currency is exchanged for another according to the quote for that given moment. Forex spread is the difference between the price at which traders are willing to buy and the price at which they sell.  
 

Forex Spread: How it works 

If the demand for a currency increases, its relative value rises. This mechanism of demand and supply plays a crucial role in defining the spreads. If one is opening a position in which there is no shortage of the base currency, the forex spread for this transaction will be lower than the spread on a transaction where the primary currency is in high demand. Brokers have no problem selling currencies that are in demand, charging a high forex spread.

  Each quote is expressed in pairs, for example, EUR/USD. Here, the Euro is the base currency and the US dollar is the counter currency. Every quote is provided with:

  • a bid price: the price at which the trader buys the base currency

  • an ask price: the price at which the trader sells the base currency

  If the quote for USD/CAD is 1.2222/24, the spread is 2 pips. Forex spread is the way in which brokers earn in the forex market. When one has to buy a currency, he or she has to pay more. On selling it, however, the trader gets less. As a result, making profits is difficult when forex spread is high.  

Forex Spreads: Dangers and Benefits 

Quality of the execution of a trade determines whether the trader actually receives tight spreads. A disadvantage of even a few pips against what is displayed on the screen can make the forex spread unfavorable for you. Following are some of the tricks used by brokers to widen the actual spread:

 

  • rejection of trades

  • delay in execution

  • stop-hunting

  • slippage

 

Forex spread is one of the determinants of the return on investment in currencies. The lower the spread, the more favorable the trade will be for the trader. Every trader tries to buy low and sell high. A spread difference as low as half a pip can make a big difference, especially when the volume of trading is high. Therefore, selecting the broker who offers the most competitive spread can make a trade profitable. 

 


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