The majority of forex currency pairs are traded without commission; nonetheless, there is a cost connected with every transaction: the spread. Instead of charging a commission, all leveraged trading platforms will include a spread in the cost of placing a transaction, which accounts for a higher asking price compared to the bid price.
Different factors determine the magnitude of the spread, including the currency pair you’re trading and how volatile it is, the size of your trade, and the provider you’re using.
Pip Spread in Forex Trading
Pips are a small unit of fluctuation in the price of a currency pair, and the final decimal point on the price quote is used to calculate the spread (equal to 0.0001). Except for the Japanese yen, where the pip is the second decimal point, this is true for most currency pairs (0.01).
Because there is a more significant disparity between the two prices when there is a broader spread, there is usually little liquidity and considerable volatility. On the other hand, a lower spread suggests minimal volatility and excellent liquidity.
In forex, how do you compute the spread?
The spread is determined within a price quote using the last large numbers of the purchase and sell price. In the image shown, the last two huge numbers are a three and a 4. You pay the entire spread upfront when trading forex or any other asset via a CFD trading or spread betting account. In comparison, when trading share CFDs, a commission is paid both when entering and closing a trade. The greater the spread, the more value you earn as a trader.
For the GBP/USD currency pair, the bid price is 1.26739, and the asking price is 1.26749.
By subtracting 1.26739 from 1.26749, the value of 0.0001 is obtained.
The spread equals 1.0 because it is based on the last large number in the price quote.
The Cost of Spreading
The 0.0004 British Pound (GBP) spread in the example above may not seem like much, but when a deal develops larger, even a small margin quickly adds up. Currency exchanges on the forex market typically involve larger sums of money.
You may only trade one 10,000-unit lot of GBP/USD as a retail trader. However, the average trade is substantially greater, involving about one million GBP/USD units. The 0.0004 spread equals 400 GBP in this more significant trade, a far higher commission. Get more information by going through the site: Forex brokers in south Africa
How to Control and Reduce the Spread
Only trade at the most favorable trading hours when there are many buyers and sellers in the market. Competition and demand for a business increase as the number of buyers and sellers for a certain currency pair grows.
Avoid buying or selling currencies that aren’t heavily traded. Multiple market-makers compete for your business when trading popular currencies like the GBP/USD pair. Only a few market makers may be willing to accept your trade if you trade a thinly traded currency pair. They will retain a broader spread as a result of the reduced competition.