If you want to start trading in Forex, the first thing you need to do is to choose a good broker. Now the question is, who is a broker? A broker is the one who creates a platform for you to trade in Forex. In easy words, brokers are the ones through whom traders trade in Forex.
At what price do these brokers sell the currency? At what price do they buy it? And how do they make a profit? If we want to know the answers to these questions, we need to know about ask price, bid price, and spread?
The price at which traders can buy currency from brokers is Ask Price. Remember, the ask price’s value is higher than the other in the pair. Let us discuss a fictitious currency pair; it will be easier to understand. Suppose it is a pair – EUR/USD = Sell 1.0717, Buy 1.0719. Notice that the higher of these two values is the ‘buy’ or 1.0719, and it is the Ask price. So, the price at which the broker sells to the traders is called Buy or Ask price.
If you want to sell currency, the broker will offer you a different price called the bid price. Remember, the Bid Price’s value is relatively low than the other in the currency price. If we look at the previous example again, we will notice that 1.0717 is relatively low between the two values. If you want, you can sell your currency to a broker at this price, called the bid price.
Not all, but the maximum brokers do not charge any commission on your trade. Now you must be wondering, where is the profit of the broker? Before you get the answer, visit https://www.home.saxo/en-sg/products/futures and learn more about the trading cost. You will notice, the broker usually make profit though spreads and commission. Now let’s get into the details so that you can understand the role of spread at trading.
To understand the broker’s profit, you have to look at the example of the currency pair mentioned earlier. EUR / USD = Sell 1.0717, Buy 1.071. Notice carefully; there is a gap of (1.0719-1.0717 = 0.0002) 2 pips between Buy or Ask and Sell or Bid Price. This gap is the profit of the broker, and it is called ‘spread.’
Is it a little challenging to understand the whole thing? Ok, let us know the whole through a simple example. Suppose you own a stationery shop. Now, you bought a product for $3.5 and sold it to your buyer for $5. So, your profit is $1.5.
The above incident means that the stationery shop owner (you) is the broker. The price at which you buy the product ($3.5) is the Sell or Bid price. Now your selling price ($5) is the Buy or Ask price. And the profit you made in this trade is $1.5, which is your spread.
Calculation of the spread of forex trading
Forex spread is measured in pips, which is the lowest unit of currency pair movement. One pip equals 0.0001 in most currency pairs. To give an example, if the value of the EUR / USD currency pair is four decimal places, then the price at the terminal (MT4 Terminal) should look like 1.1051 / 1.1053. Now the question is, what is the amount of spread here?
Simple, the gap between the two values is the spread. So, in this example, the gap between the two prices is 1.1051-1.1053 = 0.0002, and the spread is two pips. The spread calculation is an underrated step that most traders usually do not count.
Before choosing a broker, always count their credibility and acceptance in the market. But if you do not notice the difference between Bid and Ask price, I mean the spread, you have to consider excessive profit minimization.