How Forex Spread Affects Your Trading Profits
Forex trading is a popular way to make money in the financial markets.
One of the primary reasons for its current success is the ease of entry and the ability to trade from anywhere in the world where there is an internet connection.
Mobile device proliferation has also played a role, with more traders now able to access the forex trading market via a smartphone or tablet.
However, as the FX trading market continues to attract more traders, it is critical to remember some of the fundamentals of forex trading.
The forex spread is an important aspect that every trader should strive to fully comprehend before entering the market. It is the initial expense incurred by forex traders when they open a new position.
As a result, it is critical to comprehend how a forex spread affects a trader's account profits.
To fully grasp the concept, it is necessary to demonstrate how the forex spread is calculated and how its cost to an open trade is calculated.
The Bid-Ask forex spread explained
For those who are familiar with the stock market, the bid-ask spread is the difference between a stock's quoted bid price and its quoted ask price. Market forces determine the bid and ask prices in the stock market.
Things are a little different in the forex market because it all depends on the type of broker you use.
Things are similar to what happens in the stock market for those who deal with ECN forex brokers. Market forces determine the bid and ask exchange rates.
However, things are very different for traders who use dealing desk brokers, also known as market makers.
There are forex brokers who charge extremely high spreads, but there are also low spread FX brokers available on both dealing desk and non-dealing desk brokerage platforms.
The spread is determined by a market maker, which means that different brokers will quote different spreads to their clients.
For example, one broker may charge a spread of 2 pips on the EUR/USD currency pair (a pip is the smallest unit of an exchange rate up to the fourth decimal point), while another may charge a spread of 1.5 pips.
How the forex spread is applied to a trade
A trader pays 1.5 pips to open a new position, and a similar amount is added to the loss (if the trade is closed in a losing position) or subtracted from the profit (if the trade is closed in a profitable position).
As a result, for a forex spread of 1.5 pips, a trader pays a total of 3 pips for opening and closing a trade.
The overall cost can now vary depending on the broker's trading features and lot (the smallest quantity that a trader can place when opening a trading position) requirements.
Some brokers only accept standard lots, while others accept mini lots and, increasingly, micro lots. A standard lot contains 100,000 units, while a mini lot contains one-tenth of a standard lot.
In our example, a trader would pay a total of $15 to place one standard lot, or $1.5 to place a single mini lot.
The total cost will double after the trade is closed, so it is critical that the trade is closed in a profitable position.
However, cutting losses can be just as effective in the case of a trade that appears to be on a losing streak and does not appear to be recovering.
Conclusion
In conclusion, the forex market offers traders some lucrative money-making opportunities. However, not all traders become wealthy.
In fact, statistics show that the majority of traders lose money and close their accounts within the first 3-6 months of trading in the forex market.
This could be because they jumped in without considering the potential consequences of certain aspects of forex trading, such as the FX spread.
As a result, it is critical to understand how a high FX spread can affect your trading profits, as this may aid in the selection of the right broker, possibly a low spread forex broker.
