The SPREAD is nowadays known a bit by everyone but many only link it to the BTP BUND spread. The word spread means “Difference” and, in the financial sphere, has many uses:
- The spread between stocks (for example BTP BUND) tells us, in essence, what the difference in yield between two stocks is: the BTP BUND spread at 100 tells us that the Italian stock makes around 100 basis points more than the German stock of equal maturity. With the same deadline, therefore, the Italian title will yield 1% more than the German term;
- The spread on a variable rate: Our mortgages, for example, have a rate composed of an index (for example Euribor) plus a “spread” that is a difference which is the return that the bank adds to the index rate to cover costs and earn a certain amount. Euribor 3M + 100 basis points, therefore means that, once the Euribor is defined (each day it is “fixed” one), for example 0.10%, at this rate 1% will be added and, therefore, the rate which we will pay will be 1.10%.
- The bid-offer spread: This is the difference that exists in the markets between purchase prices and sales prices.
This last spread is what can be decisive in choosing your forex broker.
In the forex market, a spread is the difference in pips between the offer price and the quote ASK price (purchase / sale) of a currency pair, such as the EUR / USD. A spread is also the easiest way for many brokers to receive compensation for every transaction the customer makes through their trading platforms. This is the easiest way to understand what a spread is: EUR / USD is priced at 1.1500 the broker will offer for 1.1501 to buy or sell at 1.1499.
The trading price for any currency pair is expressed by the combination of the symbols that make up the currency pair, as well as the offer and ask price.
It is expressed as follows:
Base currency / exchange currency | Offer Price / Ask Price
If at any time the quote for the euro against the dollar is 1.1500-1.1502 we read the following:
EUR / USD = 1.1500 / 1.1502
The offer is the highest the merchant is willing to buy, also known as purchase or request price. It is the price at which the trader will enter the market if the currency pair is sold. The wonder is the minimum price you are willing to sell, also known as the price or supply you sell. It is the price that the trader will enter the market when buying the currency pair.
The difference between the bid and ask is better known as the spread. The spread is expressed as seeds or points. In this example, the spread in the EUR / USD is 2 pips or points.
The cost for each transaction
The spread is the cost of each transaction made by the market trader (with the exception of all other commissions, such as exchange or commission). This cost can vary from broker to broker. There are brokers that use the market maker and the ECN system that allows them to pay a spread but charges very tight commission for every transaction performed. Dissemination is the fundamental economic treatment for each broker and other third parties if applicable. These third parties are introducing intermediaries and / or fund managers, who can also receive compensation for their services through dissemination.
How does the spread work?
We follow this example: Trader X wants to open a selling position in EUR / USD for the price of 1,2001. Immediately, the broker executes the order and most likely executed the order at 1.1999, immediately making 1 pip on the execution. Now trader X wants to close the buying position and sell at 1.2010, but then the broker is very likely to execute the order at 1.2011 to make another pip on the execution.
In the previous example, the trader encounters a fee for each execution, in order to operate on the forex market, in order to obtain profits from each transaction. The expectation of each trade should be above the distributed amount of capitalizing on each trade. In each currency pair the spreading cost is different and the trader must also take these variables into account in order to make more money than the actual spreading cost.
Know your spread
It is very important to know the spread in the forex market. The spread is the cost of each transaction that the brokerage charges and determines if that cost is appropriate for your trading style.
Second, all investors and traders must be educated about the lack of information regarding the possibility of manipulating spreads on their trading platforms without the consent of their clients. On some occasions there are unscrupulous intermediaries who exercise this practice to get more profits. Therefore it is essential that the trader chooses a quality broker with a good reputation and who is not guilty of any spreading manipulation. It is also advisable to trade with a broker regulated by a regulatory body as their regulator requires companies to meet stringent requirements regarding financial products and services, such as the security of client funds in separate accounts.
Even if you work with brokers that do not engage in any tampering, we return to the importance of the spread as it represents the cost to the merchant. An operator that trades with low spreads will have less savings on operational and long-term costs. Therefore, a high spread trader will have to generate higher profits to offset the cost. For many traders, spreading is very important in their losses and gains. For example, if a merchant makes many short term (scalper) markets a high spread it can lead to absorbing most of their profits. For a long-term trader (swing), in which each trade generates a certain amount of seeds in profit, the spread is a matter of little relevance as it has little impact on trading results.
How to choose the best broker?
When choosing the best forex broker, you need to take into account several criteria, including the spread. The spread is a cost factor for the trader and the more you trade the more you are hit with the cost. This is especially true for those scalpers mentioned above. A low or institutional spread broker is the answer for every scalper in order to get the best rate out there.
Spreads Costs and CalculationsSince the spread is just a number, we now need to know how to spread the Dollars and Cents. The good news is if you can find the spread, finding this figure is very mathematically straight forward.
We know we can currently buy the EUR USD at 1.3564 and sell at 1.35474.That means as soon as our trade is open, a trader would incur 1.4 pips of spread. To find the total cost, we will now need to multiply this value by considering the total amount of traded lots. When trading at 10k EUR USD lot with a $ 1 pip cost, you would incur a total cost of $ 1.40 on this transaction.
Remember, pip cost is exponential. This is a way to multiply this value based on the number of lots you are trading. As the size of your positions increase, so will the cost incurred from the spread.
Now we know how to calculate the spread in pips, let’s look at the cost borne by the traders.
However, one thing clearly emerges:
- In the first case the spread is = 1.09314 – 1.09294 = 0.0002
- In the second case the spread is = 1.0940 – 1.0937 = 0.0003
It will seem little or nothing but, especially for the more advanced traders, this difference is everything !!!
And we will explain the reason to you immediately.
Let’s say that the average price of EURUSD is now 1.0900 and that, therefore, the two brokers have these two prices on their platform:
- Sale 1.0899 – Purchase 1.0901
- Sale 1.0898 – Purchase 1.0901
In this case, therefore, we assume that the purchase prices are the same while the sales prices are not. We can show you that this difference already amounts to a greater loss as soon as you open your position!
In fact, let’s say we want to buy EURUSD. In both cases the purchase cost would be $ 1.0901 for € 1. Let’s say we want to invest € 1,000 (with a lever 100 will be enough € 10 to have an equivalent position of this type!
Now I in both cases give the broker $ 1,090.1 in exchange for € 1,000 (that’s what I do when I buy EURUSD).
Exactly the instant after my operation and without the market moving, the two transactions have different value!
With broker # 1 I could immediately give back the € 1,000 and get $ 1,089.9, losing $ 0.2
With broker # 2, instead, giving back my € 1,000 I would get only $ 1,089.8, losing $ 0.3
This difference, first of all, is the broker’s gain! To make the service available to you, the broker charges you an implicit cost that is exactly the same as this spread!
From the customer’s point of view, however, this spread can determine the gain or loss.
With broker # 1 it will be sufficient for the market to move 2 pips to have a neutral position, while in the second the market must move 3 pips.
Already just investing € 1.ooo instead of € 10 it will be easy to understand that with the first broker the cost will be $ 20, while with the second of $ 30 … 50% more !!!!
This is why a small spread is very important:
- lower costs
- faster to reach the point of profit
- higher earnings