Page 46 - Module1_Introduction_to_the_Forex_Environment

Module 1 – Lesson 9 – How do traders make money

3. forex spreads
A Forex spread is the difference in price between what a Forex broker will buy the currency from you for and
the price at which they will sell it. So, for example, if you are opening a position in which the base currency is
dollars, and since there is no shortage in demand for dollars, the Forex spread on this transaction will almost
always be smaller than a spread on a less common currency.

This is again because of supply and demand. The broker will have no problem whatsoever selling off the
dollars they just bought, so they do not need to charge you, the trader, a higher spread. Whereas, if the
position's base currency was the Vietnamese Dong (yes, that is the name of the currency in Vietnam), the
spreads will typically be higher. It means the broker is taking a bigger risk and as a result can charge more for
that risk. Because of this, it is recommended for the individual trader to avoid buying or selling currencies
with lower demand. It will cost much more because of the higher spread.

If a broker were to buy and sell currencies with no change in the exchange rate, the trader would lose money
because the sell (ask) price is always higher than the buy (bid) price, enabling the broker to always make some
money on the transaction. On a small scale you see this if you exchange money at a bank when you travel.
They will always offer more when they buy your dollars then when they sell them back to you.

Another characteristic Forex brokers consider when calculating spreads is the type of account in which you
are trading. Mini accounts are typically associated with higher spreads. This is of course because the broker
needs to compensate the relatively low amount of capital being traded with a higher spread, to make their
profit.

A mini account might be trading in the tens of thousands of currency units, whereas most Forex trades are
closer to a million units. This means that if the spread is .0004 or 4 pips it can cost the average Forex trader
400 GBP or USD or whatever currency they are trading in.

Now, that we established that as attractive as Forex trading is, it is not completely cost free, let's understand
the difference between Forex spreads and stock market commissions. The primary difference is that in Forex,
you are generally only charged a spread on one side of the transaction, the “buy” side. When you buy currency
that is when brokers generally make their profit by charging you a spread.

It is extremely crucial that traders understand how significant the spread is when choosing a broker. The
difference one Forex pip can make in a broker's spread might be the difference between a successful Forex
trader and a complete Forex failure. A pip is defined as the fourth digit after the decimal.

4. how uncertainty in the market affects spreads
Impending news, such as inflation reports and central bank meetings, are the most common events that
cause spreads to widen.

Once the news of an event is absorbed by the market and it becomes clearer which way the currency will go,
the spread generally snaps back to typical levels

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