Every forex trader needs to grasp the concept of spread because it stands out as one of the essential elements in forex trading.
The spread in forex represents the gap between a forex broker's bid and ask prices and affects your potential profit or loss from each trade. Numerous forex traders fail to grasp the precise method used to calculate spreads in the forex market.
This article explains the detailed process of spread calculations in forex trading with practical step-by-step examples. After reading this article you will understand this essential pricing component.
How Do Spreads Work in Forex Trading?
At its core, the spread is the difference between two prices offered for a currency pair: the bid price and the ask price. To understand forex spreads you must start by learning about the bid price and the ask price.
Suppose you decide to buy or sell the EUR/USD currency pair. You'll always see two prices quoted:
- Bid Price: The market and your broker including BlueSuisse will purchase the base currency (EUR) from you at this price using the quote currency (USD). The base currency's selling price is what you receive when you sell it.
- Ask Price: The ask price represents the amount you must pay to buy the base currency (EUR) from the market (and your broker) in exchange for the quote currency (USD). When you purchase the base currency, you will pay this price.
The market asks for a higher price than the bid when selling the base currency. The bid ask spread forex represents the price gap between these two prices.
Your trade achieves profitability when you bridge the distance between the bid and ask prices.
The purpose behind spreads is essential to financial market operations. Brokers that use a transparent STP and NDD system such as BlueSuisse view the spread as the expense associated with executing your trade.
The spread serves as compensation for both the broker's operational expenses and access to the extensive liquid Forex market that links buyers and sellers effectively. The spread functions more as an entry fee to the trading floor while keeping market operations functioning effectively.
The spread serves as an unavoidable cost factor within the realm of forex trading. As soon as you initiate a position through buying or selling you become responsible for the spread cost.
When you purchase a currency pair you pay the ask price which is higher than the current market price. Your trading will turn profitable only if the selling price (bid price) exceeds the price at which you initially entered (ask price).
When selling currency pairs, you receive the lower bid price and you need the ask price to drop below your entry bid price to achieve a profitable transaction. You must see the market price move more than the spread amount to achieve a break-even point.
How to Calculate Spread in Forex Trading?
To calculate the spread, you need to know the bid and ask prices. You only need to perform basic subtraction to calculate the spread.
The Basic Formula
The formula for calculating the spread is:
Ask Price - Bid Price = Spread
The basic calculation shows you the initial price gap between what your broker offers to buy and sell.
A forex spread example will demonstrate how traders can carry out their forex spread calculations. The EUR/USD pair quotation by BlueSuisse appears as follows:
- Bid Price: 1.12505
- Ask Price: 1.12515
Using our formula:
1.12515 (Ask) - 1.12505 (Bid) = 0.00010
Now, let's convert this to pips. The EUR/USD currency pair uses five decimal points while the standard pip value is derived from the fourth decimal point so that 0.00010 equals exactly 1.0 pips. Fractional pips which are called 'pipettes' appear at the fifth decimal place in forex quotes.
The example demonstrates that the spread measures 1.0 pips. Entering a trade on EUR/USD at these prices leads to this immediate cost.
The forex spread calculation requires subtracting the bid rate from the ask rate followed by determining the pip value for the currency pair.
What is Pip Spread in Forex Trading?
The pip functions as the basic measurement unit for forex spreads. Using pips to measure spreads enables traders to standardize discussions of trading expenses without worrying about currency pair price levels or trade sizes.
The concept of measuring forex spread with pips functions as a standard way of quantifying trading costs similar to how distance measurements use meters or feet instead of vague terms like "it's far." Pips provide traders with an exact measurement of spread width that everyone understands.
The expression "tight spreads" or "wide spreads" in trading terminology denotes the pip distance separating the bid and ask prices.
Spread costs are lower when the spread measures 1 pip compared to when it measures 5 pips.
The monetary value of a pip spread varies based on the currency pair you are trading and your trading position size (lot size).
By displaying spread values in pips traders can easily compare the trading costs across different brokers and currency pairs without considering trade size.
Spread in Forex Trading Example
We will now demonstrate these principles by examining a specific example of forex spread calculation. You check the GBP/USD currency pair on your BlueSuisse MetaTrader platform and find this quote.
- Bid Price: 1.2550
- Ask Price: 1.2552
To calculate the spread:
Spread = Ask Price - Bid Price
Spread = 1.2552 - 1.2550
Spread = 0.0002
Now, let's express this in pips. The standard pip for GBP/USD is 0.0001 so a spread of 0.0002 represents 2 pips.
Trading GBP/USD at the ask price of 1.2552 and selling it at the bid price of 1.2550 without any market changes results in a 2-pip trading cost. Your trade will be profitable when the bid price surpasses your initial ask price of 1.2552. The 2-pip difference represents your trading hurdle because it reflects the broker's trade facilitation costs.
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