Understanding how to define spread in the Forex market is key to maximizing trading profits. The quick overview of a spread in any financial market is the difference between the amount a market maker is willing to sell a financial instrument for compared to the amount they are willing to buy a financial instrument for. Stock traders know this range as the bid versus ask spread.
Forex trading also has bid versus ask spreads. Each Forex broker has a selling price for currency and a buying price. Naturally, the selling price is going to be higher than the buying price generally speaking. This difference between buy and sell prices represents a profit opportunity for each Forex broker.
If a currency trader decides to sell USD’s and buy EUR, then the USD is referred to as the quote or counter currency. EUR is the base currency in the transaction and is always the first currency in the pair, written as:
Depending on the Forex broker, the bid/ask spread may appear as:
1.1143/45 or a 2 PIP spread
This translates to the Forex broker offering to buy EUR at 1.1143 USD and sell them for 1.1145 USD
A difference between the bid and ask numbers is known as a PIP when taken at the fourth decimal place. In our example above, the PIP is 0.0002 or more commonly called 2 PIP’s.
Knowing the PIP ranges for your Forex broker versus other brokers is one way to determine if you are getting a fair price in currency trading. For traders that move frequently in and out of the market, PIPs represent one of the largest costs trading. Those traders that trade less frequently but with higher margin do not need to worry nearly as much about PIPs as they do about their margin costs and other broker services.
By fully understanding how spreads impact profits and trading costs, a Forex trader will be able to maximize profits and minimize losses.