Before we proceed to what is spread, we need to know what is Bid & ask price in trading.
What is Bid Price?
The bid price is the price which buyers are willing to pay for a trading security.
What is Ask Price (Offer Price)?
The Ask price is the price which sellers are willing to receive for a trading security.
In a simpler way, suppose you want to buy USD you are a European citizen traveling to the USA You need to convert your euro, thus you will buy USD with euro. If EURUSD is quoting at 1.2510, that means it’s the bid price, which you need to pay in order to buy USD with your euro. You will see another quoting price which is the Ask price 1.2512. That is the price which seller will receive if he sells his USD to you. A common thought can rise in your mind, why these difference? We will explain it in next.
What is Spread?
Spread is the difference between bid & ask price. With the example above, for EURUSD spread was 0.0002 i.e 2 pips. Spread the is the cost which trader carries & brokers or exchanger earns profit from it. Spread is always a transaction cost for traders. Some forex brokers promote their brokerage services with lowest spread on EURUSD or other major pairs to draw traders attention. Because lower the spread is better the profit will be. The trader will bear low cost per trade.
How Trade get affected by spread?
Suppose you bought EURUSD at 1.2510, this price will be the Ask price (the price which buyers are willing to pay). When you will close your position you will basically sell back your EURUSD. Thus you will sell it at Bid price (the price which sellers are willing to receive). If you want to close your trade at 1.2530 then market need to reach to 1.2530 bid price in order to close your trade at your preferred price level. If the spread is 2 pips. Then your profit will be,
If you lost this trade market reaches 1.2500 stop loss, then your total loss will be,
1.2510-1.2500 = 0.0010 i.e 10 pips + 2 pips spread = 12 pips loss.
Remember, spread gets added to losses & deducted from profit. Cause spread is the trade cost which you need pay.
Spread Variation for different trading instrument or currency pairs:
Spread basically varies from currency pairs to currency pairs. The currency pairs which does have much trading volume, lower liquidity, they as usually have a higher spread. The currency pairs (major pairs) which get traded daily in bigger volume, with the better liquidity they have lower spread.
Sometime during news release spread get increased for majority brokers. To much change can cost a lot of money for the trader. Some bad brokers do this, this mechanism also called stop-loss hunting (explained later). But a little bit of change in spread during news release is common. Cause during news release time, most of the trader doesn’t execute any trades, thus low volatility causes an increment of spread.