Hello and Welcome to the ditto educational series that will provide you with the skills you need to become a forex trader!
Today we are going to be looking at spread in reference to the forex market and some of the points to remember when placing trades or deciding which broker to use and what spreads they have to offer.
firstly we must understand that in the foreign exchange market prices are shown as currency pairs or exchange rate quotation where the relative value of one currency unit is denominated in the units of the other currency in its pair.
Now that is a mouthful so let’s simplify by saying whichever forex pair you trade, When buying, the spread always reflects the price for buying the first currency of the forex pair with the second. I hope that’s clear.
The exchange rate that is given to a trader willing to purchase a quote currency is called a BID. It is the highest price that a currency pair will be bought at. The price of the quote currency selling is called the ASK. It is the lowest price that a currency pair will be permitted for sale. The BID is always lower than the ASK and The difference between ASK and BID is called the spread.
Basically the reason for the existence of the spread is so that the brokers can take a cut and can be applied instead of charging fees on your closed trade positions! Spreads are usually measured in pips and measured using the fourth decimal place in a currency quotation.
There are different types of spreads available in forex trading that different brokers provide. Let’s take a look at these two examples so you may better understand your options.
The difference between ASK and BID never changes with fixed spreads and they do not change no matter what the liquidity conditions are or if there are volatile news conditions.
Fixed spreads are great in terms of knowing where you are at all times.
You can determine your costs before entering any trade and it allows you to have better foresight in terms of your finances. They are also great in terms of ensuring that brokers can not manipulate spreads in their favour as the fixed positions can not change.
If you are a news trader and attempt to make your pips in those volatile moments of high impact news release. You can appreciate the benefits of having a fixed spread, if you would like just open a mt4 account and watch what happens to a variable spread during high impact news releases. The spreads can expand drastically and make trading a real life nightmare for an inexperienced trader.
Variable spreads differ from fixed spreads in that they fluctuate in correlation with market conditions such as liquidity and volatility.
Typically variable spreads are wide during volatile market conditions and can reach up to 50 pips in value and on the other hand can be as low as 1 or 2 pips during times of inactivity.
Variable spreads are becoming more and more popular amongst traders as tighter spreads can afford better opportunities in terms of risk and taking shorter term trades. There are also more advanced strategies that take advantage of large volatile spreads that we may discuss in our more advanced videos. Some brokers do offer capped variable spreads where a limit is set to how wide the variable spread can be which can prevent traders from suffering huge losses.
That’s all for todays video ladies and gentlemen please sit back and contemplate what you have learned as always contemplation is the key to learning.