Understanding Bid, Ask, and the Spread in Forex
When trading forex, brokers quote two prices for each currency pair: the bid and the ask.
- Bid Price: The price at which you can sell the base currency.
- Ask Price: The price at which you can buy the base currency.
- The difference between these two is called the spread, or bid-ask spread.
Why Does the Spread Matter?
The spread is essentially the cost of your trade, especially with brokers that advertise “zero commissions.” Instead of charging a separate fee, the broker builds their profit into the spread.
Think of it like selling your old iPhone to a reseller:
- If the store will sell it for $1000, they might only offer to buy it from you for $999.
- That $1 difference? That’s the spread—and their profit.
How Is the Spread Measured?
Spreads are typically measured in pips, the smallest price unit in forex.
- For most pairs, 1 pip = 0.0001
- For JPY pairs, 1 pip = 0.01
Example:
- EUR/USD quote: 1.1051 / 1.1053 → spread is 2 pips
- USD/JPY quote: 110.00 / 110.04 → spread is 4 pips
Types of Forex Spreads
There are two main types of spreads you’ll encounter, depending on your broker’s model:
- Fixed Spreads
- Variable (Floating) Spreads
🔹 Fixed Spreads
- Stay the same, regardless of market conditions.
- Offered by market maker (dealing desk) brokers.
- Brokers act as your counterparty, sourcing large volumes from liquidity providers and offering smaller sizes to traders.
Pros:
- Lower capital requirements
- Easy to calculate trading costs in advance
Cons:
- Requotes are common during volatile conditions
- Risk of slippage, where you don’t get the price you expected
Example: You try to enter a trade at 1.1000, but the broker offers a new price of 1.1010—this is a requote.
🔹 Variable Spreads
- Constantly adjust based on market conditions
- Offered by non-dealing desk brokers (e.g. ECN/STP)
- Prices come from multiple liquidity providers, not the broker
Pros:
- No requotes
- Greater pricing transparency
- Often tighter spreads during liquid market hours
Cons:
- Spreads can widen suddenly during high-impact news or low liquidity
- Not ideal for scalpers or news traders
Example: EUR/USD may have a 2-pip spread normally, but can spike to 20 pips after a major news release.
Fixed vs. Variable: Which One Should You Use?
It depends on your trading style:
- Fixed Spreads: Great for new traders, small accounts, or low-frequency trading
- Variable Spreads: Better for active traders, larger accounts, and those who trade during peak liquidity hours
If you need fast execution and minimal requotes, go with variable spreads.
Calculating Spread Costs
Now let’s turn that spread into actual dollars.
All you need to calculate the transaction cost is:
- The value per pip
- The lot size you’re trading
Example:
You’re trading EUR/USD with a quote of 1.35640 / 1.35626
That’s a spread of 1.4 pips
If you trade 1 mini lot (10,000 units):
- Pip value = $1
- Spread cost = 1.4 pips × $1 = $1.40
If you trade 5 mini lots, the cost = 5 × $1.40 = $7.00
💡 Pip cost is linear—double the lot size, and you double the cost.
Final Thoughts on Spreads
Understanding how spreads work—and how they’re built into the cost of your trade—is crucial for managing risk and calculating potential profits. Whether you go with fixed or variable spreads, knowing the pros and cons helps you choose the right broker and strategy.