Forex Spreads

Getting to Know theForex Spreads

Forex is alwayspriced in pairs between two different types of currencies. When you make atrade, you have to buy one currency and sell another at the same time. If youwant to exit the trade, you must buy/sell the opposite position. If you want toleave the trade, you will have to sell Euros and buy back US Dollars.

These days justabout every forex broker is claiming to have the tightest spreads in theindustry. But marketing does have the ability to be deceiving. The topic ofspreads in the forex spot market is very complicated and often not easy tounderstand. However, nothing affects your trading profitability more.

First of all inorder to understand the spread, you need to know what it is. A spread is thedifference between the ask price (the price you buy at) and the bid price (theprice you sell at) that is quoted in the pips. If the quote between EUR/USD ata given moment is 1.2222/4, then the spread equals 2 pips. If the quote is1.22225/40, then the spread is going to equal 1.5 pips.

The spread is how thebrokers make their money. Wider spreads will result in a higher asking priceand a lower bid price. The consequence to this is that you have to pay morewhen you buy and get less when you sell, which makes it more difficult torealize a profit

Spreads areimportant because they affect the return on your trading strategy in a big way.As a trader, your sole interest is buying low and selling high (like futuresand commodities trading). Wider spreads means buying higher and having to selllower. A half-pip lower spread doesn't necessarily sound like much, but it caneasily mean the difference between a profitable trading strategy and one thatisn’t profitable.

The tighter thespread is the better things are going to be for you. However tight spreads areonly meaningful when they are paired up with good execution. Quality ofexecution will decide whether you actually receive tight spreads. A goodexample of this is when your screen shows a tight spread, but your trade isfilled a few pips to your disadvantage or is mysteriously rejected.

Oddly enough, whenit comes to economies of scale, forex doesn't even act like most other markets.On the inter-bank market, for example; the larger the ticket size, the largerthe spread is. So when you see a 1-pip spread on an ECN platform, you have towonder if that spread valid for a $2M, $5M or $10M trade, which it prob