Understand the Exchange Spread and How It Impacts Your Trades

Fundamental Definition of Spread

When you trade through a currency broker, you always see two distinct prices for the same currency pair: the price at which you buy and the price at which you sell. The exchange spread is precisely the difference between these two values. Understanding this concept is essential for any trader who wishes to calculate their actual transaction costs.

The buy price (ASK) represents the amount you will pay to BUY the base currency in exchange for the quote currency offered by the broker. The sell price (BID) is the price at which you can SELL your base currencies receiving the quote currency. This difference between BID and ASK is often called the “bid-ask spread” and constitutes the main source of revenue for brokers that do not charge explicit commissions.

Why Do Brokers Profit from the Spread?

The structure of the exchange spread functions as a profitable mechanism for financial institutions. The broker buys currencies from its liquidity providers and resells them to you with a margin. Simultaneously, when you sell currencies to the broker, it acquires them at a lower price than it will receive when reselling. This model eliminates the need for separate fee charges, as the cost is already embedded in the buy and sell prices you see on the platform.

Classification: Fixed and Variable Spreads

There are two main models of spread:

Fixed Spread is one that remains constant regardless of market conditions or trading hours. Brokers using this model operate through a dealing desk, acquiring large positions from their liquidity providers and passing them on to retail investors. This structure allows the broker to control the prices displayed to its clients. The advantage is cost predictability, but it has significant disadvantages such as requotes during periods of high volatility and slippage during rapid price movements.

Variable (or floating) spread constantly changes as market conditions fluctuate. Brokers that do not operate with a dealing desk obtain their prices from multiple liquidity providers and pass them directly to traders without intermediation. In this model, the spread widens or narrows based on supply, demand, and overall volatility. Economic data releases, periods of low liquidity, and global events tend to significantly expand the variable spread.

Measurement and Practical Calculation

The exchange spread is usually expressed in pips. To find the spread, simply calculate the difference between the buy and sell prices. For currency pairs with 5 decimal places, subtract one value from the other straightforwardly. The same principle applies to pairs with 3 decimal places.

Let’s look at a concrete example: if the sell price is 1.04103 and the buy price is 1.04111, the spread would be 8 pips (0.8 points).

To calculate the actual cost of your transaction, you need to multiply the pip value by the volume you are trading:

• 1 mini lot (10,000 units): 0.8 pips × 1 mini lot × US$ 1 (pip value) = US$ 0.80
• 5 mini lots (50,000 units): 0.8 pips × 5 mini lots × US$ 1 (pip value) = US$ 4.00

The larger the volume or lot size, the higher the spread cost incurred in each operation.

Advantages and Limitations Analysis

Practical Guidelines for Traders

Choosing between a broker with a fixed or variable spread depends on your trading style. Scalpers and news traders tend to suffer more from expanded variable spreads, while those seeking predictability may prefer fixed spreads despite the risk of requotes. The key is always to consider the spread as an integral part of your total transaction cost when determining whether a trade is truly profitable or not.