Contents
- The Concept of a Forex Market Spread
- Types of Forex Market Spreads
- Objective Factors Affecting the Spread Size
- The Impact of Price Differences on the Forex Market
It is useful for beginner traders to understand what a spread is in the Forex market and how it affects a trading strategy. Formally, the term refers to the difference between the buying and selling price of an asset at the moment an order is opened. The spread size depends on the liquidity of the instrument and is measured in points (pips).
The Concept of a Forex Market Spread
If the current price of the EUR/USD instrument is 1.2669, the order will be executed at 1.2672, meaning the spread is 3 points. When trading one standard lot, this spread equals $30.
When opening a position, the trader immediately starts with a loss equal to the spread and will become profitable only after the price moves at least 4 points in the selected direction. This difference is charged by the broker as a commission. The amount is automatically deducted from the account when the trade is opened. Maintaining Forex market liquidity is associated with defining the maximum allowable spread. On exchange-traded markets, exceeding the established limit results in the suspension of trading.
Types of Forex Market Spreads
There are several types of Forex market spreads: floating, fixed, and fixed with widening.
A floating spread in the Forex market fluctuates within a certain range. Its specific value depends on external factors affecting the market. When sufficient liquidity is available, the spread may narrow to 0.1/0.2/0.3 points on major currency pairs. Increased market volatility generally leads to wider spreads.
Fixed spreads are established by the broker and maintained automatically. It is common practice to widen the difference between the Ask and Bid prices before important news releases due to a sharp increase in volatility caused by reduced market liquidity resulting from a limited number of active market participants.
A fixed spread with widening consists of two parts: a fixed component that remains unchanged under all circumstances, and a variable component that may be adjusted by the broker during periods of market volatility or under other specific conditions.
Objective Factors Affecting the Spread Size
- Liquidity. The most actively traded instruments are the major currency pairs: EUR/USD, GBP/USD, USD/CAD, USD/JPY, and USD/CHF. Here, the spread rarely exceeds 4 points. When trading major pairs, traders typically encounter spreads of 5–15 points, while minor instruments may have spreads of up to 50 points.
- Trade volume. Trading small volumes may result in a disproportionately larger spread because of fixed operating costs. Likewise, large-volume trading may also incur higher commissions due to the broker's increased risk exposure.
- Market conditions. Higher commissions are associated with periods of intensive trading activity, even when they are not accompanied by large trading volumes. Such situations are traditionally linked to the release of macroeconomic statistics, different trading sessions due to exchange operating hours, and public holidays characterized by reduced market participation.
- Client status with the broker. Traders with VIP-level deposits traditionally receive benefits in the form of reduced commissions.
The Forex market continues to grow in popularity, leading to increased liquidity expressed through a better balance between supply and demand. Logically, this contributes to lower commissions, since the primary factor influencing the difference between buying and selling prices is fulfilled. A balance between buyers and sellers reduces sharp price movements during the trading day, significantly lowers the risks faced by dealing centers, and creates conditions that allow commission fees to be reduced.
In practice, however, the situation looks different because the market is saturated with brokers providing access to Forex trading. As companies compete with one another, they introduce partnership programs that allow participants to earn additional income by referring new traders. These partner rewards are financed through higher commissions, meaning the price difference remains unchanged.
The Impact of Price Differences on the Forex Market
The impact of the spread on the Forex market is difficult to overestimate because trading strategies for specific instruments are often developed based on the size of the commission. Many intraday traders working on M1 and M5 charts cannot open short-term positions on minor and exotic currency pairs due to their large spreads. In such cases, strategies based on high-volume trading with profit targets of 5–10 points lose their effectiveness because of the spread.
A floating spread also affects strategies related to news trading. A sharp increase in commissions combined with the risk of slippage makes placing two opposite pending orders impractical. Most intraday strategies become completely ineffective when trading minor currency pairs because they are designed to generate profits of only 20–50 points. In addition to other factors, traders choose their instruments and trading strategies based on the width of the spread. One of the fundamental principles of trading recommends maintaining a risk-to-reward ratio of 1:3. If the expected profit is 60 points, the stop-loss should be placed no closer than 20 points. When the spread is substantial, it can significantly reduce the effective stop-loss distance, thereby increasing the trader's overall risk.
