When traders are new to the Forex market, they need to learn to create a strategy and conduct technical and fundamental analysis to guarantee profitable activities. Since you can use the best EA, everything should be easy. While the automation of trading and understanding the basics of analysis are important, the Forex spread adds another layer of complexity. The spread forces traders to adapt and optimize strategies, considering this figure in all subsequent transactions. So, what is the best spread in Forex?
What Is the Spread in Forex Trading?
The spread is the difference between the ask and bid prices, which is the cost traders pay when conducting trades in the currency market. Thus, the spread in Forex meaning is fundamental in determining the profitability of trading transactions. The bid price is the amount at which the market is ready to buy a currency pair (lower price), while the ask price is the value at which the market sells the currency pair (higher price).
The spread is not indicated in specific amounts but in pips, reflecting the smallest price movement in a particular currency pair, such as EUR/USD. How does this look? Suppose the bid price is 1.4000, and the ask price is 1.4002. In this case, the spread is the difference between these figures, which is 2 pips.
Types of Spreads
Forex spreads come in several types. Understanding the difference between them helps form an effective trading strategy.
- Fixed. It remains unchanged regardless of market conditions and currency volatility.
- Floating or variable. It completely depends on market conditions. During periods of high volatility, the variable spread increases, while during calm and stable market conditions, it narrows.
- Broker commission-based. In this model, participants pay a fixed commission per trade.
- Raw. This is the actual difference between the bid and ask prices in the interbank market without any markup or additional broker commissions.
- Fractional. Expressed in fractional pips, it provides access to smaller spreads and potentially more profitable trades.
What is the best spread in Forex? It depends on the currency pair, the time, the strategy you follow, and even the volume of working capital.
Factors Influencing Forex Spreads
The Forex spread is not fixed; it changes depending on various factors:
- Liquidity of the currency pair. It’s the market’s saturation with a currency, its popularity, and the ease of selling (or buying) it. Major currency pairs (like EUR/USD or GBP/USD) are highly liquid, which results in narrower spreads due to a large number of buyers and sellers. Less liquid currencies have higher spreads due to a low number of market traders holding the currency.
- Market volatility. The market’s stability directly affects spreads. The more stable (less volatile) the market, the narrower the spreads. During periods of instability, when significant economic news is released, the trading day opens, or major geopolitical events occur, volatility increases, and so do spreads. Consequently, the costs of trading operations rise.
- Time of day. Forex is active 24 hours a day, five days a week, but trades occur within four different trading sessions. When these sessions overlap, trading volumes increase and spreads narrow. For instance, this happens when the London and New York sessions overlap. Conversely, during quiet hours, liquidity is lower, and spreads widen.
- Different currency pairs. Spreads vary depending on the currency pairs. Major currencies have narrower spreads due to higher liquidity and the support of strong and stable economies.
Considering all these factors, a trader can choose which trading pairs to work with, which strategy to follow, and at what times to be most active in the market.
Strategies for Managing Spread in Forex Trading
A trader must consider all factors influencing spread size to effectively manage spreads. Additionally, you should choose a broker who offers favorable trading conditions. Setting stop-loss levels helps limit potential losses during the release of important economic news or completely avoid periods of increased volatility if it is not part of the trading strategy.
Before entering the active phase of trading, you should study all the spread variations observed for the chosen currency pair. Thus, traders can objectively assess the current spread, noting any deviations from typical patterns.
Summary
The spread directly affects a trader’s profitability and trading costs, which makes it a very important indicator, specifically in the context of the spreads offered by a particular broker or currency pair. Understanding spreads helps optimize daily activities in Forex trading and achieve the best results.
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