Understanding forex spreads is an important part of trading in the foreign exchange market. These spreads can influence the profitability of any forex trading account. It is not enough to ask what spreads your forex brokers are offering. You have to know what this means for your trading account and how it will affect the results of your trading activities. Forex brokers would quote different spreads, often depending on the forex trader’s account. More active accounts normally have lower spreads as compared to less traded accounts with wider spreads to compensate for the risks they assume on account of volatility.
Forex spreads are defined as the difference between a currency pair’s bid price and ask price. When you buy a currency pair, you are buying a certain amount of a currency for the value of the other currency. The price of a currency pair is quoted in terms of how much the counter currency or the quote currency is needed to buy one unit of the base currency. A pair with the US Dollar (USD) as the base currency, for example, that is priced at 1.2345 Canadian Dollars (CAD) to a US Dollar would be quoted as USD/CAD 1.2345. Using the same quote, the forex broker would put forth a bid-ask price, the difference of which represents his share of the transaction.
The bid-ask price quote are the prices at which you can buy or sell your currency pair. In the same example, your USD/CAD currency pair priced at 1.2345 can have a quote that indicates a bid price of 1.2344 and an ask price of 1.2346. The difference of .0002 between the two prices is the spread. The forex spreads allow your broker to get “paid” for facilitating the transaction. As competition among forex brokers in today’s forex industry is high, the spreads are getting tighter and tighter, bringing once common spreads of 5 to 10 pips to as low as half a pip to a couple of pips on standard lots.
More than the forex spreads, your forex broker should be concerned about the profitability of your trading account. You should be able to take advantage of price movements in the market without having to worry about whether or not your forex broker is taking your trades around with another opposing trade with spreads that are more to his favor. Your trading account’s profitability ultimately depends on how well your trades are executed. You have to make sure that the forex broker that you choose to deal with have your best interest in mind and is not simply out to take a chunk of your trading gains or even to profit from your losses.
Although you might have a trusted forex broker, you have to watch your price quotes carefully and check if they are as close to interbank rates as possible – this means tighter or smaller forex spreads. Observe market movements and economic conditions to put together a forex trading strategy that will protect you from drastic plunges and will allow you to jump at earning opportunities in surges and uptrends.
