What are Spreads in Forex Trading? | Definition & Calculation

A spread is simply the difference between the bid and ask prices. The “bid” is the highest price buyers are willing to pay, and the “ask” is the lowest price sellers are willing to accept. The spread is technically a “transaction cost” that you pay each time you trade and is one of the primary ways brokers make money. Hence, as a trader, the lower the spread, the lower the transaction cost you pay for that trade.

Key Factors Influencing the Spread in Forex Trading

Here are five key factors that influence the size of a spread in forex:

• Liquidity Levels
• Volatility Levels
• Time of Day
• Currency Pair Classification
• Type of Forex Broker

1. Liquidity Levels

First, the currency pair’s liquidity directly impacts the size of the spread. Simply put, liquidity refers to how quickly and easily the pair can be traded without causing “too much” fluctuations in the price. In forex, liquidity is primarily determined by the total trading volumes of a specific currency pair. 

Generally speaking, highly liquid currency pairs (those traded with relatively high volumes) have tighter (lower) spreads compared with less liquid currency pairs (those traded with below-average volumes), which usually have wider (higher) spreads.

2. Volatility Levels

Second is volatility, which measures how “big” a currency pair’s price fluctuates over a period of time. For example, if one currency pair usually moves by 5% in either direction (up or down) in a single day, while another currency pair usually moves by only 2%, the first currency pair is considered more volatile than the second. This also means that the first currency pair overall has a wider (higher) spread than the second pair.

Furthermore, during key economic announcements or major geopolitical events, spreads tend to widen, especially for currency pairs that are directly involved. This happens because brokers and liquidity providers take into account the increased risk and higher price unpredictability— prices tend to move rapidly during high-volatility events.

3. Time of Day

Third, while the forex market operates 24/7, five days a week, the spread’s volatility varies within the day. In general, spreads are tighter (lower) during high-liquidity periods—around 8 AM to 12 PM EST. This is usually the time with increased trading activity, thus improving overall liquidity and resulting in tighter spreads.

On the other hand, during lower liquidity periods (outside of 8 AM to 12 PM EST), spreads tend to widen (become higher). This happens because the lower trading volumes make it harder to match buy and sell orders for the brokers.

4. Currency Pair Classification

Fourth, a specific currency pair’s classification affects the size of its spread. In general, currency pairs are classified mainly into two categories: “Major Pairs,” which are highly traded currencies like the US dollar and Euro, and “Minor/Exotic Pairs”, which include less frequently traded currencies like the Turkish Lira.

As you may have probably guessed, major currency pairs generally have tighter spreads due to much higher liquidity due to larger trading volumes. In contrast, minor or exotic currency pairs—which involve at least one currency from a less liquid country—usually have wider spreads. This is due to their much lower liquidity, which in turn becomes a higher risk for brokers, who bear the increased difficulty in executing trades involving minor or exotic pairs.

5. Type of Forex Broker

Finally, the specific forex broker and account you pick also influence the spread size of your trades. This is because different brokers use different “pricing models.” These are: Market Maker (MM), Electronic Communication Network (ECN), and Straight Through Processing (STP). In general, here’s how these three different models affect the size of the spread:

• Market Maker – Brokers that “make the market” for their users/clients, like JFD Brokers, by setting both the bid and ask prices. They often dictate wider spreads, especially during volatile periods.

• ECN – Brokers that connect their clients to multiple liquidity providers (LPs), allowing them to offer tighter spreads. In exchange, they charge a commission to cover the lower spreads.

• STP – Brokers that route their clients’ orders through select LPs. Instead of charging a commission like ECNs, they automatically add a markup to the spreads, making it simpler.

How to Measure and Calculate The Spread

Here are three simple steps you can follow to measure and calculate the spread on your trade:

• Identify Bid and Ask
• Check the Difference
• Convert Spread

Step 1: Identify the Bid and Ask Prices

First and foremost, we need to get the latest bid and ask prices for a specific currency pair. 

Bid Price: The highest price at which you can sell

Ask Price: The lowest price at which you can buy

Note: Both prices are usually displayed and readily available on a broker’s trading platform.

To illustrate, suppose we want to trade the “EUR/USD” pair with the 1.1050 bid and 1.1052 ask prices. Below is what you would see on a broker’s platform:

Bid	ASK
1.05362	1.05367

Step 2: Get the Difference Between the Bid and Ask Prices

Second, we simply need to get the difference between the bid and ask prices to calculate the spread. Hence, as a formula, we can express it as:

Spread = Ask Price – Bid Price

To follow our EUR/USD example, here’s a sample calculation:

Spread = 1.05362 – 1.05367 = 0.00005

In this case, the spread of EUR/USD is 0.00005. 

Step 3: Convert the Spread to Pips

Finally, the spread in Forex is typically expressed in “pips,” which represents the smallest price movement in a currency pair. A pip is 1/100 of 1%, or 0.0001. Therefore, 1 pip = 0.0001.

In our EUR/USD example, a spread of 0.0005 equals 0,5 pips. 

Which currency pairs have the lowest spreads?

Compared to other available currency pairs, here are the top five currency pairs—also considered major pairs—with the lowest average spreads:

1. EUR/USD (Euro/US Dollar)

2. USD/JPY (US Dollar/Japanese Yen)

3. GBP/USD (British Pound/US Dollar)

4. USD/CHF (US Dollar/Swiss Franc)

5. AUD/USD (Australian Dollar/US Dollar)

Which currency pairs have the highest spreads?

In contrast, here are the top four currency pairs—categorized as minor or exotic pairs—with the highest average spreads:

1. ​​USD/TRY (U.S. Dollar/Turkish Lira)

2. USD/ZAR (U.S. Dollar/South African Rand)

3. USD/BRL (U.S. Dollar/Brazilian Real)

4. USD/RUB (U.S. Dollar/Russian Ruble)

Fixed Forex Spreads vs. Variable Forex Spreads

In Forex, brokers offer two types of spreads: fixed spreads and variable (or floating) spreads. To help you better understand these two types, here are five key differences between them:

• Price Consistency
• Broker Provider
• Price Predictability
• Order Execution
• Trader Suitability

1. Price Consistency

• Fixed Spreads – As the name implies, fixed spreads remain constant regardless of market volatility (whether the volatility is high or low). 
• Variable Spreads – Variable spreads fluctuate based on the five factors we discussed above (liquidity, volatility, time of day, currency pair classification, and the type of forex broker). 

2. Broker Provider

• Fixed Spreads – These are usually offered by Market Maker brokers since they practically control the spread. Hence, they can pretty much keep it as stable as possible.
• Variable Spreads – These are usually offered by ECN and STP brokers who source a currency pair’s price from liquidity providers.

3. Price Predictability

• Fixed Spreads – Generally provides a higher level of certainty as it allows traders to know exactly what they will pay in transaction costs regardless of the changing market environment.
• Variable Spreads – Far less predictable. The spread fluctuates based on the overall market environment (combination of different market factors) in that specific period of time.

4. Order Execution

• Fixed Spreads – During high volatility, there’s a chance for “requotes,” where the broker asks its users to accept a different price on a specific trade due to rapid price changes.
• Variable Spreads – Orders are always executed at the “best available” price without requotes. This is because spreads are adjusted automatically based on the current market environment.

5. Trader Suitability

• Fixed Spreads – Ideal for beginners and short-term traders. This is to avoid fluctuating costs, which can cause confusion or unexpected complexity for beginners. Likewise, a small change in spread can be significant for scalpers and day traders.
• Variable Spreads – Ideal for experienced traders who know very well how to manage fluctuating spreads and take advantage of them. Likewise, it is ideal for long-term traders as they can usually wait for a more stable market environment before making a trade.

How do I pick a good forex broker with low spreads? 

Doing your own research and due diligence is crucial to finding the best broker based on your specific use case. To help you find the right broker that suits you, we reviewed and compiled a list of the best no-spread brokers available right now. 

Conclusion

Overall, spreads are undeniably a crucial part of forex trading. Therefore, understanding how they work, as well as how to minimize them, can significantly enhance your long-term profitability as a trader. Moreover, mastering the different types of spreads, as well as alternatives to it—such as broker commissions or markups, will help you select a broker and account type that best aligns with your trading situation and objective. The right trading broker is essential to save costs and ensure quick order execution.

Frequently Asked Questions on Spreads in Forex Trading