Forex Spreads 101

Before we move on to more complicated topics related to forex spreads, let’s have a recap about spreads. What is a spread? It is the word used to refer to the difference between the bid price and the ask price quoted in pips. In laymen’s terms, it is the number you get when you subtract the price you sell the currency at to the price you buy it at. A pip is 1/100 of one percent.

There is more to spread than that. It is how banks and forex brokers make money. The wider the spread is the higher the ask price and the lower the bid price is. This is not a good thing seeing that you pay more when you buy and you get less when you sell. A number of factors must be considered when it comes to wider spread. A case in point is the market conditions (e.g. less market liquidity due to critical events or non-trading hours).

Banks gain profit by creating trading volume that leads to natural trading offsets. This is how banks manage to earn the whole amount of the spread. Another way in which banks make money is by increasing the spread charge above the interbank spread for foreign exchange trading.

On the other hand, forex brokers do not receive the full spread. They take out the net client currency exposure with other banks which, more often than not, cost them the spread. The spread only reimburses brokers in their endeavors while they are hoping for a change of price from the period they executed a client’s trade to the time they cut off their net exposure with a bank.