Spread Widening – What you need to know…
What is the spread?
Spread is the difference between the buy price and the sell price of a Forex pair or financial security. Sometimes the buy price and sell price is referred to as the bid price and ask price.
For example, if EURUSD has a quoted sell price of 1.0910 and a quoted buy price of 1.0912, then the spread is 2 pips, which is the difference between the 2 quoted prices.
Spreads are not fixed, they are variable, meaning that the spread is constantly changing. Spreads can increase and decrease, depending on market conditions.
Why do spreads widen?
Spread widening is the term used to describe an increase in spread i.e a spread rising from 1 pip to 3 pips.
Spread tightening is the term used to describe a decrease in spread i.e a spread falling from 5 pips to 2 pips.
Wide and tight spreads are terms used a lot in the Forex trading industry.
So, why do spreads fluctuate? It’s all about liquidity…
Liquidity – one of the great advantages to Forex trading is the high liquidity. This allows spreads to be tight as there are plenty of buyers and sellers of currency pairs. When liquidity falls, spreads can widen as there are not as many buyers and sellers at current prices – the spread has to increase to reach new levels of supply and demand.
The Forex markets can have lower liquidity during major news events and times of low trading activity. When liquidity is low, it is common for markets to become more volatile and spreads to be higher.
When will spreads likely widen?
Spreads often widen around the official market close (1700 EST/2200 UTC), during low liquidity trading hours (1700-2300 EST/2200-0400 UTC) and during major economic news events.
You can keep up to date with major economic news by using our Forex economic calendar… https://www.tfxi.com/tools/economic-calendar
Why is this important?
Knowing about spread widening is important for many reasons but here are the main 2 reasons…
- Pending orders and stop losses. Entry orders and stop-losses are triggered at spread prices, this is how all Forex brokers operate. When placing entry orders and stop losses, the spread should always be taken into consideration. A trader that knows when spreads are wider, will place a wider order, ensuring that any orders are not triggered unintentionally. This is the same for stop-losses and take profits.
- Entering new trades. For frequent traders, buying and selling at the best prices can be a priority. Trading when liquidity is high, so spreads are tight, can ensure that optimal entries and exits are executed for each trade.
How can I use this to my advantage?
Managing risk is a major part of successful Forex trading. Knowing when spreads are at their tightest allows a trader to buy and sell at optimal prices. Knowing when spreads are at their widest allows a trader to adjust stop-losses and possibly step back from the market.
Start trading with a FREE demo trading account… https://www.tfxi.com/demo-applications/create
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