What is Forex Spread?
The gap between bid (selling) and ask (buying) price in aforex trading pair. Example Let’s say you are about to trade EUR/USD, and you encounter the following: Bid Price:1.10500 - Ask Price: 1.10515 Spread = (1.10515 - 1.10500) x 10 = 1.5 pip. So even when you open your trading position, you are already on a slight losing ground of 1.5 pips.
You will be in the profit territory only when the market trades above 1.10515 for that level of price.
Why does spread exist? Brokers make profit from the spread. You can think of spread as an amount of profit that brokers take each time currency is exchanged from the source market.
Why does spread increase?
There is no hard rule as spreads may expand during these times
Market volatility: Market’s momentum may increase when economic news(like NFP, CPI, interest rate announcements, or GDP) is released, the gap becomes wider as a broker tries to protect itself from volatile market movements and high risk.
Low liquidity: A market with more traders engaged results in tighter spreads since buying and selling happen at the same pace. If there is less liquidity in the market spreads become wider. For instance, during holiday breaks (e.g., US President’s day) or late Fridays.
Trading session overlaps: Market spreads usually become tighter at peak hours which is the London-New York session overlap since liquidity is at its highest compared to Asian trading. Different types of brokers offer different spreads like fixed, variable, and Raw ECN Spreads.
Why does the spread decrease?
Active market sessions: Spreads are minimized during overlapping hours of market sessions like London & New York hours.
Liquidity: The market, particularly pairs with more trading activities like major pairs like EUR/USD or GBP/USD, generally has the tightest spreads.
Low volatility: If not much movement, the market gets predictable. Numerous competitive banks offer prices. Spread for any currency pair get minimized when lots of market makers offer their bids/ask pricing.
What is Forex Commission?
Commission is another type of Forex trading cost which is a charge taken per trade by the brokers.
How brokers determine commission?
Most of the brokers don’t have specific commissions for certain pairs but for an account type. For a standard account, they may have some hidden cost which is embedded in the spread.
Meanwhile, for Raw and ECN accounts, they often impose commission for each trade executed on almost all types of available currency pairs.
Some examples: Some brokers may charge $3.50/lot per side (means $7 round-turn commission per lot). Or they charge as low as $2/lot per side (means $4 round-turn per lot).
Which Currency Pairs Typically Charge Commission?
Currency pair commission depends on the account type that you are opening with any Forex broker not by itself.
Standard Accounts Normally, you will not see any specific commission fees when opening an account with Forex. This doesn’t mean the spread becomes cheaper, the cost has been incorporated into the spread. These pairs often include EUR/USD, GBP/USD, USD/JPY, AUD/USD.
What is Forex Swap?
Swap refers to an overnight financing cost or earnings related to maintaining open positions after a market’s daily closing time. Nearly every forex trader gets a swap, as the typical time is around 5:00 PM EST for most brokers.
Why is Swap charged?
Each currency in any trading pair has a specific interest rate.
By selling one currency and purchasing another, a trader can either make a profit or take a loss, depending on the interest rates of each currency. This difference between the interest rates is known as ‘Swap’.
When is swap charged?
Swap is credited or debited once in a day at rollover time, which depends on brokers. Most of them are around 5 p.m New York time If you closed your trading position before the broker’s rollover time, you would not incur any swap.
Positive Swap: If the currency that you bought has a higher interest rate than the currency you sold, you’ll earn interest, this is a positive swap (also called a carry trade). ##
Negative Swap: If the currency that you bought has alower interest rate than the one you sold, you’ll end up paying an interest rate, this is a negative swap.
Triple Swap Wednesday: Forex trading contracts generally settle within two business days, which mean when you trade on a Friday, it would be set in on Monday. Weekend interest are handled using a‘triple swap’ where the brokers calculate three times the standard overnight swap and add or debit to the trader’s account from overnight trades executed Wednesday. However, the swap rule can differ for currency instruments or precious metals.
Swap-Free (Islamic Accounts) Many Forex brokers offer’Islamic’ accounts that are devoid of Swap rates. This type of account is appropriate for clients who want to perform the transaction without swap fees in alignment with Islamic Finance Law (Shariah Law). Also be aware that some brokers may charge administrative costs forlong-term position holding even in an Islamic account.
Summary
The invisible profit drain every time you take a Forex trade is transactional costs. To get to grips with retaining capital, you need to understand the three broker fee tenants: Spreads, Commissions, Swaps. For all short-term scalpers and day traders looking to have micro spreads for a fixed-fee commission, your choice of a Raw/ECN account will suffice.
Conversely, if your strategy is to hold trades open over days and weeks, the benefits of a standard account, with a 0 commission rate and beneficial swap interest, will far outweigh the increased spread costs.
Make sure you review the asset specification window before entering a position, calculate your all-in cost, opt for a top tier regulated broker, and cover all positions with guaranteed Stop Loss orders to protect your hard earned cash.