Understanding spread in forex trading remains a crucial element for forex traders because it heavily influences their trading outcomes. The spread defines the price gap between the bid price and the ask price for a specific currency pair.
The spread generates profit for brokers from every transaction they execute. An ideal trading situation features small spreads but market conditions and liquidity levels cause natural variations in spreads.
When traders understand the factors affecting spreads and their subsequent effects on profits they can make better trading choices.
The article provides an in-depth analysis of the various aspects of spreads.
Our discussion will address the importance of spreads along with their impact on profits and common causes of spread changes while examining methods to reduce risks from wider spreads.
A comprehensive knowledge of spreads allows professional forex traders to optimize their profit-making potential.
How Does Spread Affect Profit in Forex Trading?
A trader's potential profit is directly influenced by the spread because it establishes both the opening and closing prices of positions.
A trade's maximum potential profit equals market pip movement in the favorable direction minus the trading spread.
If EUR/USD moves 10 pips in your favor from a quoted 1.1300/1.1302 with a 2-pip spread, your resulting profit would be 8 pips after subtracting the spread.
Even though the market continued to move 10 pips in your favor, your profit dropped to 5 pips because the spread increased to 5 pips during your trade. Increased spread sizes reduce profits because they elevate the breakeven point required for a trade.
Monitoring spreads becomes crucial when trading volatile currency pairs since these spreads can change frequently. Choosing a broker with consistent narrow spreads such as BlueSuisse enables better profit maximization over time.
Proper position sizing protects traders from losing substantial portions of their account to spread costs during individual trades.
Why Do Spreads Change in Forex Trading?
Spreads naturally experience variations because of liquidity changes and forex market condition shifts.
A variety of elements can lead to both the expansion and contraction of spreads.
- Currency pairs such as EUR/USD enjoy tight spreads because they experience high trading volumes. When market liquidity drops trading spreads expand for forex currency pairs with lower liquidity. Spreads tend to widen during overnight hours and times of significant news events.
- Brokers increase spreads during high volatility periods to manage trading risks. The broader spreads serve as protection for brokers against unfavorable price gaps. Spreads tend to tighten when volatility decreases.
- Important economic news releases trigger volatility spikes which result in broader spreads between bid and ask prices. Traders choose to delay trading activities before important announcements which results in decreased market liquidity.
- Market participation falls during holidays and weekends causing reduced liquidity and wider spreads. The likelihood of gaps increases during these specific time periods.
- Technical problems at exchanges or brokers create temporary disruptions in liquidity which result in wider spreads.
Why Do Spreads Widen in Forex Trading?
Reduced market liquidity remains the fundamental cause for wider spreads as previously explained in forex trading dynamics.
This commonly occurs during specific time periods:
- Market activity remains low from 5 PM EST Friday through 5 PM EST Sunday during overnight hours. During these periods very few Asian centers offer market liquidity.
- During major holiday periods spreads generally become wider because key financial centers are not participating.
- The occurrence of events related to elections and central bank decisions or international conflicts can cause volatility which leads to temporary liquidity shortages in financial markets.
- Orders get interrupted when major banking and broker systems face outages which causes spreads to expand until the systems resume normal operations.
- Currency pairs that include exotic or emerging market currencies which trade less often tend to exhibit wider spreads.
Why is the Spread in Forex Up at Night?
Market participation decreases overnight from late evening to early morning causing a thinning of liquidity. During nighttime hours the trading activity is limited to select Asian financial centers while European and American markets remain inactive. The scarcity of market activity results in the natural supply and demand dynamics that establish the spread range.
Brokers must provide wider spreads overnight because fewer counterparties exist to fulfill orders which results in increased trading risks due to decreased market liquidity.
The traders demand sufficient compensation for accepting sizable overnight positions given that they lack the ability to hedge them instantly. During active European and American forex trading hours when global liquidity flows improve spreads naturally decrease.
What Causes Spread in Forex Trading?
The fundamental reason spreads exist in forex trading stems from the need to exchange two different currencies.
Brokers act as market makers by earning their margin through bid and ask price quotations instead of acting as principals in trades.
Several factors ultimately determine a currency's spread:
- Brokers can hedge more liquid currency pairs with large trading volumes throughout a 24-hour period, which results in tighter spreads.
- Market participants face increased risk when dealing with high volatility. Market makers use wider spreads as a safeguard against potential unfavorable price shifts.
- Aggressive broker pricing competition leads to narrow spreads in heavily traded currency pairs.
- Advanced infrastructure technology enables brokers to reduce overhead costs which helps them offer competitive spreads.
- The elevated compliance costs faced by regulated brokers result in partially compensated wider spreads that remain fair.
- The choice between operating as a STP broker or a no-dealing desk broker determines a broker's cost structure and their capability to offer competitive spreads.
Create your free demo account from BlueSuisse to determine the spread in Forex and create your own forex trading strategies with analysis.
What Causes High Spread in Forex Trading?
Low liquidity emerges as the main reason for wider spreads in trading markets. Specific elements lead to unusually large spreads in the forex market.
- Spreads become wider during holidays, weekends or times with low market participation because these periods lead to thinner liquidity.
- Major economic and geopolitical news events trigger significant price movements that cause temporary widening of spreads.
- When major institutions face technical outages normal liquidity flows break down and spreads experience "flash widening".
- Thinly-traded currencies from emerging markets and exotic pairs naturally exhibit wider spreads.
- During severe market crises such as flash crashes liquidity disappears quickly which causes spreads to inflate.
- Currency spreads expand when government interventions take place through capital controls or sanctions.
- When brokers lack suitable derivatives such as futures to hedge risks, the spread of a currency expands.
What Determines the Spread in Forex Trading?
The main factors that dictate the spread of a currency pair include:
- Trading volume creates liquidity which results in lower and more consistent spreads for currency pairs.
- When price fluctuations increase, spreads broaden to compensate for the increased trading risks.
- The spreads among popular forex currency pairs become tighter because brokers compete fiercely to capture more market share.
- Advanced infrastructure allows providers to deliver services at reduced costs resulting in competitive pricing.
- The spreads at regulated brokers such as BlueSuisse are influenced by the expenses related to compliance.
- The decision for a broker to function as a market maker or to implement STP affects trading costs as well as broker spreads.
- The spread expands during thin liquidity periods such as weekends, holidays and during market crises.
Knowledge of spread drivers allows traders to enhance their decision-making ability and achieve greater profits despite wider pricing conditions. Let's discuss some strategies.
BlueSuisse employs advanced infrastructure and a no-deal desk model to deliver tight, stable spreads across major currency pairs for traders. BlueSuisse maintains some of the tightest spreads within the industry even when market liquidity decreases.
BlueSuisse provides clients with all the necessary tools for strategic trading and long-term return maximization through its comprehensive risk management tools, advanced platforms and tailored services.
Disciplined traders who understand the causes of spread fluctuations can leverage pricing dynamics to their advantage. Traders who focus on the most liquid currency pairs during peak trading times and implement appropriate position sizing strategies can reduce the risks associated with spreads.
BlueSuisse maintains transparent narrow spreads to establish ideal conditions that lead to consistent forex trading profits. Open a live account to explore our outstanding conditions through direct experience.