Forex Spreads and how they work?

Forex Spreads and how they work?

Forex Spreads and how they work

Investing in forex has become very popular today among individual investors and small businessmen, which was not the case in earlier times, the forex market was not always this easily accessible to everyone, and only huge financial institutions and central banks used to control the exchange market. With the emergence of forex brokers, it has now been made very easy to access the forex market and invest in this financial instrument. However, these forex brokers charge some fees for their online trading services and use their platform to trade, in the form of commission, swaps, and spreads.

There are brokers who do not charge commissions or swap fees but spreads are always included in forex broker’s charges, they are kind of built-in the ask and bid price. If you are unaware of these forex terminologies, then keep reading as we discuss forex spreads and explain how they work?

Understanding Forex Spreads:

Spread is the transaction cost involved in each of your trades. When you trade in the forex market, you open a position for either buying or selling, and then after your desired price movements, you close the position to complete your trade. For either type of trade buying or selling, your broker gives you a buying/ask price and a selling/bid price regarding a particular currency pair. The difference in both of those prices is called the spread. It is measured in pips and the most common spread rates offered by brokers range from 0.1 – 1 pips.

The higher the spread will be the more transaction cost you will have to pay to your broker, so many investors prefer to work with lower spread offering forex brokers. Their rates vary depending on the brokers themselves.

How do forex spreads work?

For most forex brokers, spreads are the only way to make money, so they offer you two prices. What happens while trading is that there is a buyer and a seller for each trade. For dealing desk brokers, they are the market maker and you are the price takers. You buy at the ask price offered by your broker and sell at the bid price given to you by the broker. The broker earns by buying at the bid price and selling at the ask price.

For example, a quote for EUR/GBP is 1.1020/1.1021:

  • If you buy the base currency (EUR) you will be paying 1.1021 ask price.
  • At the same time, if you sell the base currency (EUR), the seller (your broker) will pay you a 1.1020 bid price.
  • The difference in those prices (1.1021-1.1021) is 0.0001, which is 1 pip the spread for this currency pair.

This is how brokers earn through spreads, by selling you the currency at a little higher price than they bought from liquidity providers and buying from you at a little lower price, which is referred to as spreads in forex. This is the case with dealing desk brokers as they control all the positions offered to you.

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