Learning the basics of trading is essential for traders. Knowing the terminology is just as important as knowing how to use it in trading. For this reason, this educational article is going to focus on a basic concept: the forex spread.
What is forex spread?
In a previous article, we explained what the Bid and Ask price is. Simply put, the spread is the difference between the bid and the ask price. This difference is based on changes in decimals also known as pips.
In other words, the spread is the subtraction, the difference between the bid and the ask price of an asset. Before investing in an asset, you can see these values displayed next to each pair like in the image below.
If we focus on the EURUSD pair, we can see that the Bid price -at the time the image was taken- is 1.20715 and the Ask price is 1.20717. If we subtract the two figures, we get 0.00002 pips. This figure is the spread.
What is a spread used for?
The spread is used to measure the liquidity of the asset to be traded. If many traders agree to trade the EURUSD at the same time, it shows that there is a lot of interest in the pair and that many people are investing in the pair. We could say that the pair is liquid because there are a lot of people interested in it.
If we have a look at the SGDJPY, we see that it has a spread of 0.035 pips at the time of taking the image. This pair’s spread is larger than the spread for the EURUSD. This is because the interest for the Singapore Dollar against the Japanese Yen is not as great as the interest shown by investors for the EURUSD. Therefore, there are fewer people interested in investing in this pair, which translates into less liquidity for this pair.
In short, when the difference between the bid and ask price, the spread, is very small, it indicates that there are many people interested in this asset and the spread is low. If, on the other hand, it is very large, it indicates that there is very little movement in that market and therefore the spread is high.