Retail Forex Spreads

Retail Forex SpreadsTrillions of dollars’ worth of currency change hands every day in the foreign exchange currency market (FOREX).

Governments, international banks, and multi-national corporations trade their native currencies for the currencies of the foreign countries where they are doing business. These entities attempt to make the exchange when it is most favorable to them. This is the wholesale level of Forex trading. It takes place because of the absolute necessity of swapping currencies in order to fulfill some financial obligation with the preferred currency of the party receiving the payment.

Individual traders are able to participate in this market at the retail level. Retail traders generally will be compelled to pay a higher fee for the right to access the Forex markets than will the wholesale traders.

In Forex terminology this fee is known as the spread.

The spread is the difference between the selling price and the buying price of a currency pair. It is commonplace to hear the buying price referred to as the bid and the selling price as the ask or offer.

In a Forex currency transaction, the trader will buy at the bid price and sell at the ask price. What this means is that every new trade initiated starts off at a loss equivalent to the spread, which is measured in pips.

Consider this hypothetical example.

A trader wishes to purchase 1000 units of the EUR/USD currency pair when the exchange rate is 1.3200, meaning that each euro is worth $1.32 in the United States currency, from a Forex provider who is charging a two pip spread. The Forex provider will charge the trader the spread, two pips, which mean that trader will actually be paying $1.3202 for each euro. At 1000 units, this fee, calculated in U. S. dollars is equivalent to $.20. This sounds insignificant until you consider that many retail traders will trade tens and hundreds of thousands of currency units in each transaction.

Traders at the retail level of currency trading must attempt to do everything in their power to keep the cost of trading as low as possible.

The reason is simple: the cost of trading is deducted from profitable trades, but added to losing trades. Over the course of hundreds or thousands of trades for millions of currency units, Forex spreads represent a significant percentage of the trader’s profit and loss statement.

Some Forex providers charge variable spreads based on the currency pair involved and the volatility of the currency market at any particular time. This actually supplies the trader with a valuable clue. Low spreads indicate a market that will not have much price activity and is probably best ignored. High spreads reveal that prices can change dramatically and rapidly, meaning that caution is required.

Other retail Forex providers have fixed rates, but they add a commission either to each trade or based upon a certain number of currency units.

Determining the best Forex provider for any particular trader’s trading capital, average trade size and trading style requires a little basic mathematical analysis to ascertain which type of retail Forex provider will supply the lowest possible trading costs.

 

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