What is a spread?
In margin forex trading, there are two prices for each currency pair, a "bid" (or sell) price and an "ask" (or buy) cost. The bid price is the rate at which traders can sell to the executing firm, while the ask price is the rate at which traders can buy from the performing firm.
For example, when you see the price quote of EUR/USD is 1. 2881/1. 2884 as in the above picture, the bid is 1. 2881 whereas the ask is 1. 2884. Which means traders looking to sell must do so at 1. 2881, those looking to buy must do so at 1. 2884.
The difference between the bid and ask price is the actual spread, which constitutes the cost of the trade. In fact, all traded instruments - stocks, futures, currencies, bonds, etc. - have spread. If a trader buys at 1. 2884 after which sells immediately, there is a 3-point loss incurred. The trader will need to wait for the market to move 3 points in favour of his/her position in order to split even. If the market moves 4 points in your favour, he/she starts to profit.
Many online trading firms like to promote margin forex trading as an almost cost-free instrument -- commission free, no service charge, no hidden cost, etc. Traders should know that spread is the cost of trading, and in fact, it also represents the main source of revenue for that market maker, i. e. the forex trading company. The spread may appear to be a minuscule expense, but once you add up the cost of all of the trades, you will discover it can eat away quite a portion of your account or your profit. If you check the price tag of a T-shirt before you buy it, do the same thing whenever you trade forex, look into the spread before you decide to trade. Your trade needs to surmount the spread (the cost) before it profits.
Know your expense: the spread
Spread may be the cost to a trader. On the other hand, it is a revenue source of the firm who executes the trade. In the foreign exchange market, the spread can vary a lot with respect to the executing firm and the parties involve. Inter-bank foreign exchange can have spread as tight as 1-2 pips, while the bank can widen the spread to 30-40 pips when dealing along with individual customers. If you check out the spread of those small exchange shops nearby the tourists' sights, you may find the spread can go up to 400 to 600 pips.
Because of keen market competition, the spread of online forex trading is getting tighter in the past few years. For major online forex companies, their spreads are essentially the same.
It is important for a trader to obtain the tightest spread as possible, but anything that is far lower than the typical spread is skeptical. The spread is the main source of revenue of a forex trading firm, when the firm cannot earn enough from the spread, there maybe some other hidden cost in the transaction.
Another point to note is that many market makers often widen the spread when market conditions be volatile, thus increasing the cost of trading. For instance, if an economic number comes out that is off expectations, thereby creating a flood of buyers or sellers, the market maker may often widen the spread to revive the balance between buyers and sellers. As a result, traders should inquire about the execution practices of their clearing firm; firms with poor execution of orders and a tendency to widen spreads will ultimately lead to higher trading costs for the end user.
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