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Why Spreads Matters in Forex Trading
Written by: PaxForex analytics dept - Wednesday, 03 January 2018 0 comments
While the movement between currencies was once the preserve of traders who worked for large investment banks, today there are hundreds of forex brokers that make available online platforms which allow anyone with a bank account to speculate on the movements within the forex markets. However, buying and selling currencies via foreign exchange brokers can be quite expensive as there are normally quite sizeable spreads between buying and selling prices. The spread, or the difference between the bid and ask prices on platforms, has always plagued traders trying to make it or break it in this 24-hour market.
When you trade forex you are speculating that one currency will rise or fall against another. When you open a new position, you are effectively buying one currency while simultaneously selling another. When you close that position you’re doing the reverse — selling the currency you bought and buying the currency you sold. And if the currency you initially bought has increased in value against the currency you initially sold, you’ll make a profit. The difference between the buying (ask) and selling price (bid) in a currency pair is called the spread and this is effectively the cost of your forex transaction.
It is super essential to fully grasp the importance of spread in forex trading since it has a significant impact on whether you are going to be a profitable forex trader or not. In very simple terms, the spread is the difference between the bid and
ask price. Ask price is always higher than bid price and the difference is banked by the broker as a profit. This is the fundamentals of money making for a broker. For forex brokers, one and only purpose is to make money out of your trades and spread is the most basic way for them to fulfill this purpose.
The spread is the cost of each transaction performed by the trader in the market (not including any other fees such as swap or commission). This cost can vary from broker to broker. There are brokers that use the market maker and ECN system which allows them to charge a very tight spread but charge commission for every transaction executed. The spread is the basic compensation for each broker and other third parties if applicable. These third parties are introducing brokers and/or money managers, who can also get compensated for their services through the spread.
It is important to remember that spreads are variable meaning they will not always remain the same and will change sporadically. These changes are based on liquidity, which may differ based off of market conditions and upcoming economic data. To reference current spread rates, always reference your trading platform. If you trade frequently on the forex market you should select a broker that charges the lowest spread. Avoid brokers with a bad reputation especially in the manipulation of prices.