How can you calculate the spread in Forex trading?

Forex trading is based on the value of currency pairs and their relationship. The difference in value between them is known as the spread. In this article, we will discuss the spread, how you can calculate it, and what types of spread there are.
 
Are you considering opening a position in forex? A unique asset, forex is very different from other trades. One element you must understand before investing is the spread, which describes the difference in currency pairs. Below, we discuss the spread, how it is worked out, and the many factors that can influence it.

What is the spread in forex?

Forex is traded in currency pairs. When investing, you will notice a difference between the buy and sell prices. This difference between them is the spread. Also known as the bid/ask spread, it is a way for the broker to make money on a trade.  

To understand the spread, you must first understand that forex trading is conducted using pips. These are decimal movements in the price of a currency. For example, if the USD was $1.0000 and moved to $1.0001, it would have moved up by one pip.

How do I calculate the spread in forex? 

Despite the large number of decimal points, calculating a spread in forex is quite simple. All you need to do is subtract the bid price from the asking price. The decimal points that are left become the spread. 
 
Imagine we are trading USD/GBP and the bid price is USD 1.3092. The asking price is GBP 1.3094.
 
Ask price 1.3094 – Bid price 1.3092  = Spread 0.0002. In this case, the spread is 2 pips.  

It is worth noting that spreads can change. Spreads that are close together are described as tight spreads. Many investors prefer these as trades are more affordable. They are a sign that markets are stable.  

When markets become volatile, then spreads will get bigger. These are described as wide. Generally, more stable world currency pairs will have tighter spreads as they have stronger relationships. Lesser known ones will have wider spreads, as they can be more volatile. 

What is the difference between variable and fixed spreads?

When you sign up with a forex broker, they will offer either fixed or variable spreads. Both have advantages and disadvantages. 

A fixed spread stays the same, whatever the ask or bid values. The advantage of this is that it remains constant and is not subject to market volatility. The downside is that generally, a fixed spread is slightly higher than that which you would find with variable spreads. It is best if you want to hold long positions or you are new to trading.
 
A variable spread will change. As the ask and bid values move, then the spread will change from tight to wide spreads. This tends to allow people to capitalize on market volatility and big changes.

What are the other types of spread in forex? 

There are several other types of spread that you may experience in forex trading. The most common ones are collected below.

Yield spread

A yield spread is the same as a bid and ask spread. However, they are more commonly used for assets other than forex. 
 
Bonds are one of the most common assets where these are used. However, they are calculated in a very similar manner to forex. If a bond has a yield of 5% and one has a yield of 7%, the yield spread would be the 2% difference. You may find yield spreads used to express values about major currency pairings. 

Negative spread 

These spreads only apply to brokers, so as a trader you are unlikely to encounter them. They happen when the bid is higher than the asking price. As an investor, with negative spreads, you get to trade without having to pay a broker anything. 

It usually happens when currencies have a high interest rate. A broker makes a profit from holding or trading the government’s currency, so they essentially finance customers for using this pair.

What can change a spread?

Numerous different factors can change a spread. As the market runs 24 hours a day, it is different from other assets and this poses a unique set of circumstances. The time of trade is one of the key factors in the changes. When currency trades are made in a different trading session, so if GBP was booked when its exchange was closed but the Asian market was open, the spread would be wider.  

Other factors are global events and economics. Anything that can impact the rise and fall of a currency will influence forex spread. For example, a war in Europe could impact currencies, introduce volatility, and widen the spread. Even GDP and employment figures can do this. 

Knowing what the spread is and how to calculate it is crucial if you want to trade in forex. It is vital in understanding the market. Know that all investments carry a risk. Find a quality broker and manage your finances, only investing what you can afford to lose. Use a dummy account before starting, and get to grips with forex trading before using your capital.