When trading in the financial markets, especially Forex, you will often hear the word spreads. The spread is one of the most important costs every trader pays, even if they don’t notice it directly. Understanding spreads is key to better decisions, lower trading costs, and stronger risk management.
What Are Spreads?
In simple terms, spreads refer to the difference between two prices of the same asset.
In Forex, it usually means the difference between the bid price (selling price) and the ask price (buying price). This gap is the cost you pay to enter a trade, and it goes directly to your broker or liquidity provider.
For example, if EUR/USD is quoted as 1.1050 / 1.1052, the spread is two pips.
Spreads exist in Forex, stocks, bonds, commodities, and even derivatives. They reflect market liquidity, volatility, and competition among brokers.
Why Spreads Exist
Before exploring the different types, it is important to understand why spreads exist at all.
Spreads are necessary because:
- Brokers and liquidity providers need compensation for facilitating trades.
- Markets need a small price difference to process buying and selling efficiently.
- Higher volatility creates uncertainty, so the gap widens to manage risk.
- Low liquidity requires a wider difference to match orders safely.
In short, spreads are a built-in mechanism that keeps the financial market running smoothly.
How Spreads Work in Forex Trading
To understand spreads clearly, consider how a typical Forex quote works.
A currency pair always has:
- Bid: the price at which you can sell.
- Ask: the price at which you can buy.
The spread = Ask – Bid.
Small Example
If GBP/USD is 1.2700 (bid) and 1.2703 (ask), the spread is three pips.
This means you start the trade -3 pips negative the moment you enter a position.
So, the tighter the spread, the cheaper it is to trade.
Types of Spreads
Because spreads change with market conditions, brokers offer different structures.
1. Fixed Spreads
These spreads stay the same regardless of market volatility. They are common in market-maker brokers and are ideal for beginner traders who want predictable trading costs.
Best for: low-capital traders, news-avoidance strategies.
2. Variable (Floating) Spreads
These spreads change depending on liquidity, volatility, and market events. They can be very tight during calm periods and widen during high volatility.
Best for: experienced traders, scalpers, and day traders.
3. Commission-Based Raw Spreads
Some brokers offer spreads as low as 0.0 pips but charge a separate commission. This structure is often used in ECN and STP accounts.
Best for: high-volume traders and algorithmic trading.
What Affects the Size of Spreads?
Before diving into the spread impact, here’s what causes spreads to widen or tighten:
1. Market Liquidity
Highly traded pairs like EUR/USD and USD/JPY usually have very tight spreads.
Exotic pairs like USD/ZAR or USD/KES have wider spreads due to fewer participants.
2. Volatility
During unstable market conditions, spreads widen to protect brokers from risk.
Typical examples include:
- News releases (NFP, CPI, rate decisions)
- Sudden market shocks
- Major geopolitical events
3. Time of Day
Spreads are tighter during major market sessions like:
- London
- New York
They widen when liquidity drops, such as during rollover.
4. Broker Type
- ECN/STP brokers → tighter spreads, but with commissions
- Market makers → slightly wider spreads, no commissions
Why Spreads Matter for Traders
Understanding spreads is essential because they directly affect your profitability.
Here is how:
1. Trading Costs
The spread is your first cost on every trade.
A wide spread means you start your position deeper in loss.
2. Scalping and Day Trading
Short-term traders rely on tight spreads to reduce cost.
Even a 1-pip difference can affect performance.
3. Position Sizing and Risk
Large spreads increase risk and reduce reward-to-risk accuracy.
4. Profit Targets
High spreads can eat into profits, especially for traders using tight stop-loss or take-profit levels.
Examples of Spreads in Real Trading
To make the concept more practical, here are simple examples:
Example 1: Major Pair (Tight Spread)
EUR/USD: 0.8 pips
A trader entering a 1-lot trade pays around $8 in spread cost.
Example 2: Gold (Moderate Spread)
XAU/USD: 20–30 pips depending on the broker and liquidity.
Example 3: Exotic Pair (Wide Spread)
USD/KES: spreads may range between 30 and 100 pips, depending on liquidity.
How to Choose a Broker with Good Spreads
Here’s what traders should check:
- Compare spreads across brokers in real time.
- Look at both normal spreads and news-time spreads.
- Understand if commission accounts offer better overall pricing.
- Check if spreads remain stable during market openings.
- Avoid brokers with extremely wide or unpredictable spreads.
How to Reduce Spread Costs
Although spreads cannot be removed, you can minimize them strategically.
You can reduce spread costs by:
- Trading during major market sessions.
- Avoiding news-time volatility.
- Choosing ECN or raw-spread accounts when possible.
- Using limit orders to avoid unnecessary entries.
What’s the Difference Between Spreads and Commission ?
This is a common point of confusion.
- Spread → hidden cost.
- Commission → visible, fixed fee
- Raw spread + commission accounts often offer lower total costs.
Your choice should match your strategy.
Final Thoughts
Spreads may look small, but they play a huge role in trading costs, execution, and long-term profitability. A trader who understands spreads can choose the right broker, time trades better, avoid unnecessary losses, and build a stronger overall strategy.
Whether you are a beginner or a professional, spreads are part of every trade you take. Mastering them is part of mastering the market itself.
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