The Spread is another important term you need to know when you start trading Forex online. You need to be familiar with the spread, because it represents the cost of your deals.
As you already learned the Bid is the price at which you Sell and the Ask is the price at which you Buy.
The spread is the difference between the Bid and the Ask price in a Quote.
Why is it important to know what is a Spread?
Usually there are no commission when you trade Forex online. In contrast, if you trade shares the commissions can go up to couple of hundred of dollars per trade. A lot of traders are attracted to currency trading by the lack of commissions. However you should know that this doesn’t make the trades free.
You should take a note that your cost in Forex trading is actually in the Spread. The Spread is how the Forex brokers make their money.
How does the spread actually become a cost for you?
You already know what is a pip and how to calculate the value of a pip. As a result you can calculate that the spread of EUR/USD with a quote 1.1856/1.1858 is equal to 2 pips:
1.1858 – 1.1856 = 0.0002
So how these 2 pips become a cost for you? The reason is that for each trade you make, in order to reach break even, the market price should move at least one spread in your direction.
Here is an example, so you can understand better:
You can see that Ask chart is always higher than the Bid chart. This is due to the spread. Although the Bid price is following the Ask price upwards, there is always a spread distance between the two. As a result when the Ask price goes upwards, the Bid always needs some time to reach the breakeven point. If the move is strong, this time can be short. However sometimes the price needs more time to reach breakeven, or even it can revert before doing so.
Why you should be careful about the spread in your Forex trading strategy?
Too many novice traders ignore the spread when choosing a broker or evaluating the performance of their trading strategy. The truth is underestimating the spread costs, can be devastating to your account. Unexpected spread widening can wipe out an otherwise profitable trade. 300 deals at 2 pips spread will have 300 pips less profit than 300 deals at 1 pip spread.