How to Calculate Forex Spreads and Their Impact on Your Trades
4/22/2025, 9:24:22 AM
What are spreads and how to calculate them? What could be the impact of spreads on your trading? Find answers to these questions in this article.
How to Calculate Forex Spreads and Their Impact on Your Trades
If you are new to trading, you might have heard of many strange terms. One such commonly used term is “spreads.” Do you know what it is or how significant could it be in your trading? In this guide, you will learn the core concept of spreads, different models surrounding spreads, and their potential impact on your trading.
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What Are Forex Spreads?
When you look at the currency prices, you see two prices with a nominal difference. These two prices are bid and ask. When you buy a currency pair, you get the bid price. When you sell it, you get the ask price. That nominal difference between the two is called spread. This is a cost for your trading, but it is a revenue for the platform provider.
Why spreads are important
Since this is a cost you bear to trade, it is very much important. A higher cost can lead to lower profit margins. This is a universal business principle and Forex is no exception. The difference between prices is measured in a unit called pips. Let’s elaborate it further in an example.
Trader A opens ten positions in a day, and each position has an average spread of one pip. So, he pays ten pips in a day or 220 pips in a month. Now, if his lot size is 0.10, he pays nearly $220 each month. Let’s assume his net profit is $500 a month. What if the average spread cost reduces to 0.5 pips? His cost will be halved, and this saved cost will add to his profits.
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How to Calculate Forex Spreads
Now you got the foundation, let’s move forward to calculate the spreads and primary factors that influence Forex spreads.
Calculating Spreads
Calculating spreads is not a hard job. Most of the trading platforms display this information on the charts or in the watchlist. However, you should know how they are calculated to have an edge.
The formula of spread = Ask price - Bid price
Now’ let’s take an example. Look at the image below:
You can see the bid and ask prices at two different places. If subtract ask price from the bid price, you get 0.00003. This is your spread. Since the standard way is to measure in pips which is fourth place after a decimal, the spread is 0.3 pips.
Factors Influencing Spreads
Spreads keep changing every moment. Sometimes, they are tight and sometimes they are too wide. There are several factors responsible for this. Here are a few:
Liquidity
It is the most significant factor when it comes to spreads. Higher liquidity means more orders at a particular price point which in return gives tight spreads.
Asset type
Commonly traded assets have low spreads. For example, EUR/USD is the most traded pair. You will find spreads as low as zero at some instance. However, EUR/SGD is least traded pair and it has a minimal spread of 4 pips.
Timing
The timing is also very important for the spreads. Markets during active hours have low spreads while inactive hours have usually wider spreads. Mostly London session is considered active. Also, when New York and London sessions merge, we have a high liquidity, resulting in low spreads.
Economic Releases
During the release of high-impact news events, the markets go wild. At such moments, the spreads spike up in almost every asset.
Volatility
Highly volatile times have higher spreads as people refrain from taking risk and there are low number of orders.
Fixed vs Variable Spreads: Pros and Cons
When it comes to spread models, we have two broader categories.
Fixed Spreads
Market makers use this model. There is a fixed spread on major pairs, crosses, exotics and commodities. The spreads are high like 3 pips on EUR/USD.
The main advantage of fixed spreads is, you can avoid slippages. You are charged a fixed cost. You can plan well before execution. The disadvantage is a higher cost. When you can get spreads as low as 0.1 pips, then paying 3 pips is too high. Especially, if you are a scalper, you lose your edge with fixed spreads.
Variable Spreads
ECN models offer variable spreads. Here, spreads are driven through market forces. Higher liquidity means lower spreads while lower liqudity means higher spreads.
The major advantage of variable spreads is low cost of trading. Scalpers and day traders can enjoy a higher profit. Slippages and wider spreads at certain times are the disadvantages.
How Forex Spreads Impact Your Trades
We have talked a lot about the spreads. Do you know, why? The impact is too big on your profitability. But you can smartly use this for your advantage.
Effect on Profitability
Low spreads are your advantage. Remember, when you see spreads too high, refrain from trading. Being a high-frequency trader, each pip charged as a spread matters. Your profitability decreases when you are charged a higher spread.
Strategies to Minimize Spreads
Here are few things you could do to minimize spreads:
Trade highly liquid assets.
Trade during active market hours.
Refrain from trading exotic pairs, especially when you are a scalper.
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Conclusion
Spread is a cost of trading. Higher spreads means higher cost. Hence, look for the assets and timings when spreads are not volatile and remain low and consistent. You can avoid higher spreads by trading highly liquid assets and trade only when markets are active and spreads are low.
