Introduction
The Forex market is one of the most popular financial markets in the world in terms of its size and liquidity. Millions of traders conduct foreign currency trades on a daily basis in hopes of earning profits from price differences. However, in order to make profits in foreign currency trading, it is very important to understand how much your investment will cost and which currency pairs you may be interested in. Two main aspects that all traders should consider are calculating the spread in forex and identifying the most traded forex pairs.
Calculating the Spread in Forex
Spread is the difference between two prices, at which you can buy and sell currencies in foreign currency trading. Calculating the spread is quite important in order to estimate potential expenses and determine the price when you enter a particular trade.
For example, EUR/USD spread can be calculated by analyzing such price quotes:
1.1050 / 1.1052
The first number denotes the price of the bid, and the second number indicates the price of the ask. This difference is known as the spread.
In this example:
1.1052 – 1.1050 = 0.0002
This spread is equivalent to 2 pips.
How to calculate spread in forex
It is crucial to learn how to calculate spread in forex as this will allow traders to calculate their costs when trading forex.
The formula is simple:
Spread = Ask Price – Bid Price
For instance, if the quote of GBP/USD is as follows:
1.2705 / 1.2708
Then,
1.2708 – 1.2705 = 0.0003
This would indicate a spread of 3 pips.
Example
USD/JPY = 145.20 / 145.23
Spread = 0.03
The above equals 3 pips.
Importance of Forex Spreads
Spreads affect your trading bottom-line since every trade begins with a loss equivalent to the spread due to the fact that you are buying at the higher price and selling at the lower price.
In case you have been charged 2-pips spread by your broker, the market must move in favor of 2 pips in order to realize any profit.
Generally, lower spreads are more favorable compared to higher spreads. For instance, lower spreads work well for scalpers and day traders.
Facts that Influence Spreads in the Foreign Exchange Market
Several facts affect whether the forex spread will be wide or narrow.
The first important fact is liquidity. The more liquid a currency pair is, the narrower its spread is since there are a lot of buyers and sellers in the market.
Market fluctuations may influence spreads too. Brokers tend to widen spreads during periods of political instability or economic news releases.
The type of the broker may also be important for spreads. The ECN brokers will offer narrower spreads, yet they will charge you commissions, whereas the market makers will add the commissions to wider spreads.
Introduction to the Most Popular Currency Pairs
Currency pairs are classified by three groups: majors, minors, and exotics. The most traded forex pairs will fall into the majors category because they represent the world’s leading economies.
The most popular currency pairs are traded more frequently because they allow traders to achieve better spreads and stable liquidity.
Most traded forex pairs
The most traded forex pairs constitute the majority of the foreign exchange volume since they are highly stable and liquid.
EUR/USD
EUR/USD is the world's most widely traded forex pair. EUR/USD includes the euro and the US dollar. This currency pair is highly liquid and offers low spreads.
USD/JPY
USD/JPY is the currency pair that shows the rate between US dollar and Japanese yen. This currency pair is characterized by liquidity and quick market movements in the morning (Asian) trading sessions.
USD/JPY is significantly affected by monetary policy decisions and market sentiment.
GBP/USD
GBP/USD is a pair of the British pound and US dollar; it is also called Cable. This pair is characterized by increased volatility compared to EUR/USD.
The movement of GBP/USD is determined by economic data in the UK and in the USA.
USD/CHF
USD/CHF includes two major currencies – US dollar and Swiss franc. The Swiss franc is viewed as a safe haven currency when economic conditions get worse.
AUD/USD
AUD/USD stands for the pair of the Australian dollar against the US dollar. Prices of commodities, mainly metals and gold, affect AUD/USD.
USD/CAD
The USD/CAD currency pair is greatly affected by prices of oil, as Canada is an oil exporting country.
The two currencies usually experience strong movements when the price of oil changes.
Why Traders Prefer Major Currency Pairs
There are many reasons why most traders prefer to use major currency pairs in their operations. The main reason is that they provide more favorable trading conditions.
The first is a lower spread that reduces trading expenses. The second is higher liquidity which makes it easy to execute trades.
One benefit of using major pairs is low slippage in times of volatility. Because of high volumes in these markets, trades are filled easily.
Using major pairs is recommended to novice traders as well.
Conclusion
Knowing how to calculate the spread in forex is important in minimizing trading costs. The spread is the difference between the bid and the ask price, meaning that it shows the cost of trade. Narrow spreads usually create more profitable trading opportunities for traders.
It also makes sense to be aware of the most traded forex pairs. This information is necessary to ensure that one trades in liquid and profitable markets.pairs.