Spread - Currency Trading

What is a Spread in Currency Trading?

In currency trading, the spread is the term used to describe the difference in pips between the bid price of a currency pair and the ask price of the same currency pair. This difference or spread is how bankers and other currency traders make their money, and it operates with the same general stock market principle as buy low and sell high. However, although with stock trading you generally are looking for sell price that is much higher than the price at which you bought your shares (a wide spread), traders of foreign currency are looking for as tight a spread between the bid and ask price of a currency as possible. The trading fees are based on the bid/ask spread and a wide spread means higher fees and a lower trading profit. The following example will help us to understand how the spread in foreign currency trading works.

Consider the currency pair of the British pound (GBP) versus the American dollar (USD). If the currency pair GBP/USD currently has a bid price of 1.3484, then the market will pay us 1.3484 dollars with every 1 pound we are selling; that is, the market will bid us $1.3484 dollars for every £1 that we have for sale. The ask price for this same GBP/USD pair might be 1.3486, which means that market will charge us $1.3486 dollars for every £1 that we want to purchase; that is, the market is asking $1.3486 as payment for £1. In this example, the spread is 2 pips because the difference between the ask price and the bid price is 0.0002 or 2 percentage in points. For us to make money on the aforementioned transaction with the currency pair GBP/USD having a bid price of 1.3484, we would want to buy the pair at that price and then hope that the ask price comes down to 1.3483 or lower. In this scenario that market would bid us $1.3484 when we sell £1 to the broker. Later, when the market is asking $1.3483 to give us our £1 back, we will pocket $0.0001, minus any commissions of course.