A spread is the difference between the buy and sell price of a currency. The value is measured in pips which is found by taking the 4th digit after the decimal (in most cases expect for the JPY when it’s the 2nd digit). Instead of a transaction fees, the spread is the cost for the brokers’ services.
The value of the spread is used to calculate the total spread cost. For example trading a 10k EUR/USD lot with a $1 pip cost would cost a total of $1.40.
1.4 (Pip Value) x $1 (Pip Cost per 10k lot) = $1.4 (Spread Cost)
The pip cost raises proportionally to the lot size, so the larger the lot size the higher the cost of the spread.
The average size of a spread differs depending on the market. In the interbank market the spreads are narrow and competitive in contrast to the retail market where spreads are usually quite large.
Types of Spreads:
Fixed spread – The spread remains constant and is not influenced by market conditions. Brokers set fixed spreads for automatic trading accounts.
Fixed spread with an extension – A portion of the spread is kept constant and a broker in correlation with the market adjusts another portion.
Variable spread – The spread is not constant and will change sporadically. These changes are determined by the liquidity of a currency. Furthermore the spread is influenced by market conditions and new economic data. The spread is low during periods of market inactivity and high when the market is volatile.
Popular currency pairs are traded with low spreads compared to unlikely pairs because of liquidity. The size of a spot deal can also influence the spread value. Middle-sized deals are quoted with tights spreads as opposed to small or big deals with bigger spreads. This is because of the risks involved.
A strategy that can be implemented using variable spreads is exploiting its minimum and maximum values. When a currency reaches a minimal spread (0 to 1 pips) a trader simultaneously opens to buy and sell positions. Then at the moment of maximal spread closes both positions.
The profit will be equal to the maximal spread value. This strategy is of low risk as profit doesn’t depend on currency pair quotation but spread value. In addition, opening at minimal spread guarantees breakeven and high possibility of profit.