Welcome to Plan B Trading. In this short segment,
we ask the question: What is the spread? I’m looking at the spread in the context
of trading, rather than something to put on the toast in the morning.
Some terms are used that were introduced in the videos “What is a Forex account” or
“What is spread betting”. These videos can be accessed from the FAQ page at www.planbtrading.com.
The spread is an inevitable part of trading and is the profit taken by the broker.
When trading Forex, whether through a Forex account or using spread betting, the broker
does not charge you a fixed or monthly fee for operating the account.
The broker does not take any direct transaction charges for taking a trade either.
Instead, the broker offers two different prices for a currency trade, often referred to as
the bid price and the offer price. These are the brokers prices, describe what the broker
is doing, the broker is bidding and offering. You buy at the offer price and sell at the
bid price. The difference is called the spread and is the brokers profit margin.
Let’s look at some examples. These are the prices at which I can buy and
sell Eurodollar, the currency pairing of the Euro and the US Dollar. The price you can
sell them to the broker is 1.2612. This is the bid price, or what the broker is bidding
to buy your currency. When looking at Forex charts, it is most common to have the bid
price displayed. If you wanted to buy this currency from the broker, you would have to
pay 1.2614. This price is called the offer price, or ask price, or the price the broker
is offering to sell you the currency. There is another price called the mid price.
The mid price, as it’s name suggests, is the middle point between the two prices. Take
the bid and offer price, add them together and divide by two to obtain the mid price.
The mid price is not often used, as you can’t actually trade at this price. It may be useful
when the market is very slow or volatile. Currency movements are measured in pips.
The spread is the difference between the bid and offer prices and is expressed as a number
of pips. To calculate the spread, move the decimal
point four places to the right and simply deduct the bid price from the offer price.
In this example, Eurodollar is trading with the spread of 2 pips. When you look at a price
chart based on the bid price, you need to add the spread to the bid price whenever you
are contemplating buying the currency to find your true cost.
Spreads on different currency pairs vary. The calculation is the same, so move the decimal
point four places to the right and deduct the bid price from the offer price to obtain
the spread. Cable is trading here with the spread of 3 pips.
On some of the less commonly traded currency pairs, it is normal to see spreads a lot higher.
Here, the Kiwi Dollar and the Swiss Franc are trading with the spread of 7 pips. You
might decide this is too high for you to trade. Your might restrict the currency pairs you
trade on certain strategies as a result of the spread.
When it comes to trades involving the Japanese Yen, the decimal place is moved two places
to the right to calculate the spread. In this case, the Aussie Dollar is trading against
the Japanese Yen with a 4 pip spread. Competition amongst brokers is fierce and
often seen in their advertising by the spreads they quote. Eurodollar is the most heavily
traded currency pair and usually has the tightest spreads. Brokers are keen to let you know
how tight (or narrow) their spreads are on Eurodollar.
From 2 pips, there are not many steps down to zero, so many brokers have moved to pricing
at 5 decimal places. To calculate the spread still means moving the decimal point 4 places
to the right. In this example, the spread is 1.3 pips.
The equivalent for pricing the Japanese Yen is to quote the price to three decimal places.
The decimal place is still moved two places to the right to calculate the spread, which
at this moment is 2.8 pips. Most brokers now use variable spreads. This
means the broker can change the spread at will. During periods of normal trading, this
leads to very competitive spreads. When trading is “thin” , which means not
very much activity, brokers often widen their spreads. This can sometimes be seen at the
beginning of the week when the market is opening and at the end of the week when it is about
to close. Given spreads are variable, it can mean the bid and offer price moving quite
independently of each other. This can also happen at times of high market volatility.
Although the spread is the brokers cut, it is not generally seen as a transaction cost.
When trading, the focus is on the bid and offer prices at the moment in time when the
trade is executed. You can see the impact of the spread at the
precise moment you take the trade. For example, trading Eurodollar at £2 per pip with the
spread of 1.1 pips results in a cost of £2.20. Rather than focus on this cost, you will be
looking at the P&L as the trade progresses and either the net profit to you, or the total
cost. A quick recap on spreads.
Spreads on currency pairs vary by currency pair. Most traders focus on the major currency
pairs for trading, as the spreads are more competitive.
Competition amongst brokers is fierce. Don’t assume all brokers give the same bid and offer
prices, or the same spread. If you have multiple trading accounts, shop around.
Market conditions can affect spreads. Most brokers use variable spreads allowing them
to take advantage of slow markets. If you still have questions, why not call
0203 603 4983 and talk to a trader now. You’ll learn how to use spreads and place
pending orders when you attend Trading 101, our entry level course.
Book your place on Trading 101 or have a chat with one of our traders by calling 0203 603
4983 now. You can find more information about coaching
and our training programmes and you can book online at www.planbtrading.com