The Significance of the ‘Spread’ in Forex Trading – Part 1

Filed under: Learn Forex Trading |

 

A lot of people underestimate the significance of the spread in forex trading, so today, I would like to take you through the fundamentals of the spread, and to explain why it is the single most important element of forex trading.

 

The ‘spread’ is the difference between the ‘bid’ (sell) price and the ‘ask’ (buy) price. Essentially, it is the difference between the buy and sell price and this is how your broker makes money. For example, if you were to initiate a buy on the GBP/USD forex currency pair, and then were to sell it instantaneously, then you would not break even, but rather, you would make a loss because of the spread.

 

If you have ever played roulette at the casino, you will know that there are 38 numbers, with two of these numbers belonging to the house, and you get a 36-1 payout on any winners.  This means that in the long term, you will most definitely carry a loss and the house will most definitely win. This is similar to the spread in forex. Your broker has a ‘house’ advantage.

 

This makes being profitable in forex very difficult. Over the weekend, I came up with a system that was incredibly profitable (in fact, I got very excited for a while). However, it was a trading system with a high volume of trades, and once I factored in the spread, the profit, if any, was minimal.

 

There are a couple of things you can do to counter the damaging effects of the spread. The first is to find a reliable broker who offers low spreads. The second is to trade on the higher timeframes. The second of these options requires a little more explanation, so I will go through the ins and outs of this in part 2 of this article – coming shortly…

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