It is super essential to fully grasp the importance of spread in forex trading since it has a significant impact on whether you are going to be a profitable forex trader or not. In very simple terms, spread is the difference between bid and ask price. Ask price is always higher than bid price and difference is banked by the broker as a profit. This is the fundamentals of money making for a broker.
When you go to the exchange office in your neighborhood, you will see way higher spreads compared to online forex brokers. Why? It is always pointed out as one of the greatest advantages of leveraged online forex and I would prefer to delve into this topic in another article.
As you have realized by now, forex brokers are not in the industry as saviors who bother to deal with all the mess in order to be able to render you all those awesome services such as leverage, mobile trading platforms, wide range of instruments so that you would be able to invest in currencies even on your phone and grow your capital. Forex brokers’ one and only purpose is to make money out of your trades and spread is the most basic way for them to fulfill this purpose.
Wider the spread is charged, higher profit that the broker makes. You have guessed it right, guys. This extra profit for the broker by widening the spread is created at the expense of yours. So there is a zero-sum relationship between forex brokers and forex traders in terms of profit.
Why Does Spread Matter?
You are going to feel the pain on wider spreads stronger if you are an intraday trader or scalper where you are chasing few to several pips on your trades. Here is an example; let’s assume that you are scalper and your strategy is targeting only 5 to 10 pips. Now imagine that Broker A is charging 3 pips spread on EURUSD whereas Broker B is charging only 1 pips.
You are going to earn 2 pips higher on your every EURUSD trade if you trade with Broker B and that is equivalent to almost 50% of your total profit in the case that your take profit target is 5 pips. Thus you can improve profitability of your strategy as much as 50% by just switching from Broker A to Broker B.
Furthermore, spread is where those phony forex brokers generally try to manipulate the market conditions on their behalf. Widening spreads without the consent of the clients to gain more profit is the easiest and most common way of scamming traders in this industry. Spread is where you have to be over cautious for the sake of your capital and future earnings. You should monitor the difference between bid and ask price and compare it with what the broker advertised and offered you upon opening your account.
One easy way to monitor the spreads is by enabling Spread section on Market Watch window in MetaTrader platform. Make sure those spreads are what you were offered and charged when you open a new position.
Fixed spread could be considered as a solution against shady spread exercises. There are few forex brokers out there who offer fixed spreads which means that they guarantee that spreads won’t fluctuate at any moment. However, these type of brokers’ earning model poses another risk for profitable traders which I am going to talk about in another article.