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By Will Ellis

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Last Updated on March 14, 2024

Edited by Adam Turner

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Fact checked and reviewed

Investing in the forex market is one of the smartest things a trader can do. It doesn’t matter if you have never invested in anything before, or if it’s something you have done for decades, the forex market will grant you many opportunities that you haven’t had before.

For many reasons, investing in forex is different to investing in just about any other commodity in any other marketplace. Because of this, even those who are considered seasoned traders find new and exciting things that draw them into forex trading.

Yes, you might find incredible success investing in forex, but that will only be true if you know what you are doing. Just like any other market, there are many minute and specific details of which you should be well aware.

You can get by if you don’t know all of these things but if you wish to thrive in the forex market – or any market, really – you need to treat yourself as a student, one who wishes to learn, study, and become an expert.

That means you need to know the ins and outs of the forex market – including the spread. This is something that will be built into literally every transaction you make. Therefore, it is something that should be completely understood. 

Table of Contents:

• What Is The Forex Market
• What Is The Spread
• How Is The Spread Calculated

What Is The Forex Market? 💱️

Forex means “foreign exchange” and is essentially buying or selling one currency for another.

Yes, it is true that you can make money by trading money. It might sound silly on the surface, or confusing, but it makes total sense and this booming industry has made trillions of dollars over the years.

A smart investor can take their own currency and then exchange, or buy, a different currency from a foreign nation. This can be advantageous for a number of reasons. Some people do it so they can buy a different currency, hold onto it, and then sell it at a higher price, hopefully making a strong profit for themselves.

Other people want to do business in other nations and investing in forex is a smart way to do so. If you are doing a lot of business in Germany, for example, you should be using Euros to buy products and establish a business, rather than always converting Australian dollars.

It makes more sense to use the forex market because you stand to make a profit and, therefore, have more money to spend on your business interests in Germany. 

However, whenever you are buying or selling your forex, you need to be aware that there is a small, somewhat hidden fee that is built into every single transaction.

This is called the spread, and it needs to be totally understood before you start your forex journey. 

What Is The Forex Spread? 💸️

You must comprehend the fundamental elements of every forex deal in order to understand the forex spread and the way it impacts you and your trading.  If you don’t, you might be disappointed to discover that you are actually spending more money than you expected each time you initiate an exchange.

In the world of forex trading, all trades are done through middlemen, paid professionals who demand a fee for their hard work on your behalf. You don’t have a say in the matter, this is something that is built into the market. 

Online Only 🖥️

The forex market is all online. There is no central hub or headquarters. You do not do your trades at a physical location, such as the American New York Stock Exchange, which has an actual location in New York. 

Instead, all forex trades are done completely online and through these professionals who carry out your wishes and oversee everything done between sellers and buyers. These people moderate and maintain the system that allows the forex market to thrive. 

What Is The Spread?

The “spread” is any forex deal’s cost for the gap between the listing value and the asking price of the bid.

Think about it this way: the buying and selling amounts for a particular currency pair are represented by the two rates. When buying currencies, you must pay a particular amount. But, if you wish to sell it back straight away, they must sell it at a lower price than the buying price.

You need the forex market to sell that currency. But unlike the American stock market, where trades take place in an actual location, the forex market is different. The foreign exchange market has always been electronic.

To manage this electronic marketplace, a middleman is required to organise the transaction, even if the buyer and vendor are in different cities or countries.

This middleman’s duties include locating a bidder for every seller, in order to ensure an efficient stream of buying and selling orders for foreign currency.

Why Do They Earn The Spread? 💰️

In actuality, there are some dangers associated with the specialist’s work. For instance, they might approve a purchase order at a specific price, but the worth of the currency rises before they can find a seller.

Alternatively, the specialist might be required to accept a larger order to sell than the buying order they had committed to filling, but they are still accountable for having to fill the approved bid price.

The market maker keeps a portion of each transaction as compensation for assuming the risk and executing the deal. The spread is the percentage they retain.

A coupling between currencies may be less fluid than some other pairings if the spreads are significant. In other words, the exchange between the two particular currencies is receiving less attention from investors and traders. In this situation, it is less likely that somebody will provide a price that is nearer to the other side of the deal. 

The spread rises as trading volume decreases, in part to cover this risk. Brokerage firms might add trading commissions in the spread even though they advertise their service as commission-free.

How Is The Spread Calculated? 🔢️

How does the market determine the spread? It’s actually easier than you might imagine.

Each and every forex quote on the market is made with two important pieces: the bid and ask prices. This is a lot like what you see in other markets. 

The bid is the price what the market or the broker will buy the base currency at in exchange for the other currency. The ask price is the value at which the broker will sell the base currency.

The spread is the difference between these two. It is a simple formula that takes the bid and the ask and gives the difference to the broker.

Other Factors ➡️

However, there are other things that affect the amount of the spread. It isn’t just based solely upon the formula above. Instead, there are exterior things completely out of the broker’s control that can drive the amount of the spread up or down.

The Time Of Day ⏲️

The forex market is available and open all day long, 24/7. That means that people can buy and trade all day long and deep into the evening. But the spread may be different depending on when you decide to make your move.

If you are buying your currency during the normal trading session for the currency, there will be many brokers available to help you with your trade and the spread will likely be lower. However, if you are buying it at a later hour, there will be fewer brokers. Therefore, your spread will likely be costlier. 

World Events 🗺️

There are many current economic and political events throughout the world that can impact the size and cost of spreads in the forex market. If the unemployment rate in the United States comes out and is shockingly high, the US dollar is most likely to fall in value.

When that happens, the forex market is affected and the spreads for that dollar can be much wider since the rates of exchange are going to fluctuate. 

Other events, such as wars, elections and unrest among populations can also impact the value of currency. The coronavirus pandemic, for example, led to record inflation which affected the value of many currencies throughout the globe. When they lose value, spreads are higher. 

Conversely, when a currency gains value or rebounds, the spreads related to it on the forex market might be smaller and easier to handle for traders. 

Numerous factors can influence the size of the spread in the forex market, leading to both favourable and unfavourable outcomes. However, it is important to recognise that the presence of the spread is a constant.

As an aspiring participant in the forex market, it is crucial to understand that the spread cannot be altered or circumvented. It is an inherent characteristic of forex trading that should be factored into your overall trading strategy and decision-making process. But you can be aware of it, prepared for it, and able to work with it. 

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