The Basics of Forex Bid Ask Spread

Forex or currency trading is different from trading other financial instruments in many aspects. One major difference among those is the commission-free trading. Trading FX trading is totally devoid of brokerage, ECN, market maker and trade execution commissions or fees. But this does not mean that the brokerage firms are non-profit organization offering free services. Brokers benefit from the difference in bid and ask prices or bid-ask spread. Different brokerage firms offer different brokerage spreads. In forex trading, this bid-ask spread plays a major role in determining the profit or loss of trades and is one of the major factors to be considered when choosing a brokerage service. Bid-ask spread is also a basic forex trading phrase that every trader should thoroughly understand.

What is Bid Ask Spread?

In trading any financial instrument including forex currencies, stocks, bonds or commodity futures, bid is the highest price a buyer willing to pay and ask is the lowest price a seller willing to sell. Bid ask spread is the difference between the two prices. In other words, bid-ask spread is the amount by which ask price exceeds bid price. The narrower the difference between the two prices the tighter the spread.

The spread of a currency pair is identified by determining the pip difference of the forex quote. Or it is the pip difference of the currency pair price values. If EUR/USD is showing a price of 1.3490/1.3792, then the spread difference is 2 pips.

Which Factors Determine Bid Ask Spread?

Market liquidity is the main factor determining bid ask spread. When there is high liquidity in the market because of high number of trades, the spread can be very tight. But on off-peak trading hours the spread can be very wide. During daily trading, the pairs have varying liquidity which can affect the bid-ask spread offered by the brokerage firm. For example, EUR/USD will be most liquid when both European and US trading sessions converge but, can be not-so-liquid when both sessions are not active.

Brokerage firms offer different bid-ask spread for trading currency pairs. These can be fixed or floating or combined. Most brokers offer fixed and very tight spreads when there is liquidity in market and floating or wide spreads when the market lack liquidity. The spread also vary with currencies, popular pairs have very narrow spreads and less popular or exotic pairs have very wide spreads.