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Home  >  Trading basics  >  Forex spread

Forex spread

Forex spread is the single most important element in determining profit and loss in the foreign exchange market. A forex spread is the difference between the buying price and the selling price. As a general rule of thumb, a forex quote wll have four decimal points, with the exception of the Japanese Yen. Each 0.0001 represent one pip (Price Interest Point) or point, which is the smallest, basic unit to calculate profit and loss. For JPY, one pip is equivalent to 0.01, since it is quoted in only 2 decimal point.

As an example, a USD/CAD = 1.1240/45 represent a spread of 5 pips. Although this may not seem like much, a small movement like this can mean thousands of dollars in lost or profit for high rolling investors. To give you an idea, most currencies usually trade with a range of 100 - 150 pips a day.

The spread is retained by the broker as their profit. Although brokers do not charge any commisions, the cost of transaction is built into each trade using forex spread. According to forex author Noble Drakoln, "this spread can range from five to seven pips, the equivalent of approximatelyUS$35 - US$49." Assuming that the spread is 5 pips, a trader would need at least a 5 pips movement in his favor in order to break even. Any favorable movement above 5 pips serve as profits. This also mean that even if the pip remained unchanged, the trader will also suffer a loss of 5 pips.

To calculate profit or loss, one will have to dividing the pips with the value of the currency. For example, if a trader gained 1 pip from a EUR/USD quote and the current value of the USD against the Euro is 0.88, one pip is valued at 0.000113. However, when trading with quotes using the USD as the quote currency, the value per pip is fixed at $10. Hence, a 10 pip gained is equivalent to a $100 in profit and the same applies for losses. To decrease the risk and value of each pip, author Ed Ponsi of 'Forex Patterns adn Probabilities' points out that, "If this scenario creates more risk than the trader wishes to incur, he or she could open a 'mini' account. In a mini account, the EUR/USD currency pair has a constant pip value of $1..."

Some brokerage will be willing to give a better spread with big investment of $500,000 or more. Apart from comparing softwares and facilities, looking at the spread offered by brokerage firms can save you a sizeable amount of money with the increased trade activities.

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