What Are Spreads in Forex Trading?

When trading forex or CFDs, you will usually see two prices for each instrument: the bid price and the ask price.

The difference between them is called the spread.

The spread is one of the main costs of trading. It affects the price at which a position is opened, how far the market needs to move before a trade can become profitable, and the overall cost of entering and exiting positions.

Key Takeaways

• The spread is the difference between the bid and ask price.
• The bid is the price at which you can sell, while the ask is the price at which you can buy.
• Spreads are commonly measured in pips.
• Tighter spreads generally mean lower trading costs.
• Spreads can widen during periods of low liquidity, high volatility, or major economic news.
• The spread should be considered alongside position size, stop loss, and overall risk before entering a trade.

What Are Bid and Ask Prices?

The bid price is the price at which you can sell an instrument. The ask price is the price at which you can buy an instrument.

So, if EUR/USD, for instance, shows:
Bid: 1.1998
Ask: 1.2000 
This means you can sell EUR/USD at 1.0998, or buy it at 1.2000. The ask price is usually higher than the bid price. The gap between them is the spread – 2 pips in this case.

Brokers and Spreads

While spreads occur naturally in markets, they are also the most common way brokers charge traders for their services.

Forex & CFD brokers will often have a minimal spread. This means that, regardless of market conditions, the spreads can’t drop below a certain level.

This is often a very minor spread, equaling a few pips, but it does mean that traders need to perform a little better to remain profitable. Naturally, a broker with lower spreads on your preferred instrument will normally be the optimal option, assuming there are no other charges/fees.

Why Do Spreads Change?

Spreads are not fixed. They can change depending on market conditions, the currency pair, liquidity, and timing.

Major currency pairs, such as EUR/USD or GBP/USD, often have tighter spreads because they are heavily traded. Exotic pairs, which involve smaller or less commonly traded currencies, often have wider spreads because there are fewer buyers and sellers available.

Spreads can also widen during quiet market hours, around major economic news, during holidays, or in periods of market stress. This is because there may be fewer buyers and sellers available, or because prices are moving too quickly for liquidity providers to quote as tightly as usual.

Conclusion

Before opening any trade, check the spread. A setup that looks reasonable with a 1-pip spread may become much less attractive if the spread suddenly widens to 5 or 10 pips.

Spreads significantly impact the price movement you need for a trade to end up in your favor. Beginners may want to stick to highly traded asset pairs like majors and avoid volatile periods like news releases and reports. This will allow them to get familiar with how spreads work in a more reserved environment before moving on to trading patterns that may be more hectic.

The spread should be part of your pre-trade planning, along with your entry, stop loss, position size, and risk. It may seem like a small detail, but small details matter in forex, especially when leverage and frequent trading are involved.