Apart from working their usual 9 to 5 jobs, there are many people who pursue various legal-friendly practices to earn some extra perks, of which trading is one popular practice. While the financial fanatics participate in trading to prove their financial cognizance, there are many of these novice traders, who engage in trading for the sole purpose of making some decent money. Of all the different trading markets available for the pursuers, the foreign exchange trading or the forex trading has captured the wide attention of eager traders due to its simplicity and profitability.
It is certainly simple to understand the forex trading practices, as many of us are accustomed to foreign currency exchanges owing to overseas traveling that is either inevitably a part of our job’s requirements or simply due to our mere eagerness to visit the fascinating global destinations. Either way, we are benefitted by the basic awareness of foreign exchange practices, which when further cultivated and carefully trained can enable us to pursue the forex trading methodologies earnestly in a profound manner.
With respect to profitability, there are several significant factors that determine its value, of which the contribution of spread is highly commendable. All those people, who desire to follow forex trading either as their passion or profession should thoroughly understand its characteristics to know, how and what influences spreads in forex trading and at the same time, to gain some serious profits.
Spread- what is it?
Like all other trading markets, the currency market also works on the basic principle of supply and demand, where the demand for a particular currency increases its value in the market, which in turn affects the spread. Now, the spread is nothing, but the difference in price at which the forex broker buys specific currency from you and the price at which he/she sells them to make a profit. In simple terms, the spread is the difference in price between the ‘selling’ amount and the ‘bidding’ amount of a specific currency pair.
In forex trading, the currency exchanges are facilitated in suitable pairs, mentioned as, for e.g., EUR/USD, where the EUR or Euro is the base currency and the USD or the US dollars is the counter currency or the quote currency.
The spread is mainly decided by the base currency, which when in high demand enables the broker to quote lower spreads from you, whereas if the currency is in lesser demand, then owing to the risk factor involved in selling it, the broker would undoubtedly quote a higher spread from you. Also, understand that the broker can quote a profitable spread only when you are the buyer, who is interested in buying certain currency pairs from him/her.
Types of spreads in forex trading
In forex trading, following are the commonly used spread types.
Here, the difference in the ASK and BID price remains constant, irrespective of the fluctuating market conditions. While the fixed spreads might look profitable, during certain inactive market conditions, the variable spreads can offer more profitability for the traders offering lower spread value.
Fixed spreads with extension
While a certain part of the spread remains unaffected by the market conditions, the dealer may choose to alter the other half part, suiting to the market’s behavior.
As the name implies, the variable spreads vary in accordance with the market’s condition, in where one might enjoy lower spread value during market inactivity, and, whereas the volatile market situations might dangerously lead to higher spread value.
The factors that influence the spread value
The following factors are the major contributors of spread, which must be thoroughly considered by any trader to enjoy profitable forex trading with a suitable, broker low spread aspect.
The currency liquidity factor
As we have seen already, the popular currency pairs always involve lower spread than the unusual currency pairs for the obvious reason of risk involved. Hence, to enjoy a reasonable spread only trade in those currencies that have higher liquidity value.
The market behavior aspect
If you want to engage in profitable forex trading that involves low spread value, then participate in forex trading practices only when the market is busy with many prospective buyers and sellers of foreign currencies so that, owing to the obvious competition, you might easily find a broker who quotes a reasonable spread value that is usually lesser than the value he generally quotes, otherwise.
The status of a trader
If you are an established trader, who is known for bulk foreign exchanges, then naturally you might invite favorable spread quotation from dealers, who could still earn some reasonable profitability, despite narrowing their spreads, owing to the bulk nature of the foreign exchange transactions involved.
Thus, the spreads can largely affect your profitability of the forex trading practices, which can be consciously avoided by choosing the right broker who offers reasonable spread value that doesn’t affect your profit alarmingly!