Making a Forex trade involves the exchange of currency. The currency is always priced in pairs. When making a trade you must buy one currency while simultaneously selling another. Once you make the commitment to trade you will need to complete the deal. Should you need to exit the trade you will need to buy and/or sell the opposite position. Leaving the trade will require you to sell Euros and buy back in US Dollars.
Spreads are a Forex trader’s friend, because nothing affects your profitability more. Brokers that have the tightest spreads will usually see the most business. This is why just about every broker is claiming to have the tightest spreads in town. Understanding the spread in a Forex spot market is very complicated. The spread is the difference between the bid and the ask price. The quote will be given to you in pips. The “bid” is the price that you can sell currency at. The “ask” is the price you can buy currency at. A pip is the smallest unit by which a cross price quote changes. For example; if the quote you receive between EUR/USD is 1.2222/4, then the spread equals 2 pips. If the quote is 1.22225/40, then the spread is going to equal 1.5 pips. Spreads are important because the affect the ability to make a return on your investment.
The spread is the commission base for all brokers. It is how they make their money. Wider spreads result in larger broker commissions. Creating a wider spread is the result of having higher ask prices and lower bid prices. There are consequences with using this formula. As a trader you will end up paying more when you buy and less when you sell. This lowers your profit potential. Using a broker that has a tighter spread is always in a Forex trader’s best interest.
Just because your broker has a tight spread does not automatically mean you will turn a profit. You will also need a proven trading strategy. If you have poor execution you will not be able to determine if broker you are using has a wide or tight spread. For, only a tight spread executed well will produce the kind of profits that will make you a success. In Forex trading your main goal is to buy low and sell high. Therefore, you will not want to limit your dealings with broker with a wider spread, because that means lower profit earning abilities. A half-pip lower spreads does not sound like much. However, it can easily mean the difference between making a profit and losing your shirt. A good example is when your monitor shows a tight spread, but your trade comes in a few pips higher.
Forex trading is one of the few financial trading methods that does not follow the conventional trading floor. On the inter bank market the larger the ticket size the larger the spread. This is not automatically the same for Forex trading.
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