Daily Forex #5 - How Forex Spreads Work
Every market has a Spread and so does Forex. In simple terms, this is the difference between the Buy and Sell Price of a currency. When you go to the money changer to exchange currencies, you will always see that each currency has 2 different prices. The difference between the prices is the spread.
In financial terms, a spread is defined as the price difference between where a trader may purchase or sell an underlying asset. Traders that are familiar with equities will synonymously call this the Bid: Ask Spread.
To understand better, lets take a look at this example. Let's say we had a USD/JPY bid price of 105.00 (that is the price at which the broker is willing to BUY the USD) and an ask price of 105.05 (the price at which the broker is willing to SELL the USD). In this case, the spread is equal to 0.05 or 5 pips, and that money goes straight into the broker's pockets.
Most #Forex brokers do not charge a commission on trades because they already earn from the spread, unlike a stock broker who earns more from commissions.
It is also important to point out most Forex brokers do not make most of their money from the spread but by taking the other side of their client’s trades, most of whom lose their money, which goes straight into the brokers’ pockets.
Most people, when they lose money from Forex trading, think that their brokers are out to cheat them. But this is simply not true. Think about it. A Forex broker does nothing else but give you prices at which to trade after taking your deposit. If you, and the clear majority of their other clients, trade badly and lose all your money without ever withdrawing any profit, then they will make much bigger profits by keeping your deposits than they ever will from any spreads and commissions that you are charged.
Therefore, the spread is far more important to you, as a trader, than it is to the broker. It is your “cost of doing business”, and the more trades you take, the more important the spread becomes to your overall profitability.
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This is a very entertaining article, but I would like to learn more about spreads.
If you want to learn more about spreads, then you should probably read this great article about tight spreads. I recently spent several hours analyzing the market and realized that this is very important information in order to properly engage in trading. For me personally, this information was extremely useful and the most important thing is that it was extremely exciting.