Spread in Forex – FX Guide

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A spread is a very simple concept, both in the case of Forex assets and other financial instruments. It is commonly asked in Kenya, “What is the Spread in Forex?” To understand how forex spreads affect you, you must understand the general structure of any forex transaction.

Trade is conducted through intermediaries paid for their services, according to one way of seeing the trade structure. The spread for each pair of currencies is determined by a facilitator who finds buyers and sellers and adjusts the price on both sides.

Spreads represent the difference between a bid and an offer, the result of which is the charge. Generally, spreads are brokers’ sources of income in Kenya. The broker’s “liquidity provider” handles trade execution and helps the broker make payouts.

Liquidity providers also have their spread, so if the broker wants to make any money, they either need to charge traders a commission or mark up the spread. Read the article below to find all about Forex spreads and their effective use.

What is Spread in Forex?

How do spreads work in Forex? Regardless of the term, a spread is a difference between the price of buying and selling currency pairs or assets. A higher spread means a trader is less likely to make money from their trading activities.

Forex brokers in Kenya earn most of their revenue from spreads. They usually have a fixed spread that guarantees the company a steady income. The larger the spread, the more revenue the company receives.

Forex pairs with major currencies offer the best spreads. Currency such as USD, EUR, GBP, JPY, etc. When these pairs are used in the pair’s construction, the spread is almost guaranteed to be extremely low. EUR/USD is the most actively traded currency pair on the market, so this is even more relevant.

What are the types of Forex spreads?

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There are many different spreads out there, even though they all serve the same purpose of earning the broker income. Almost all of them are important to know, but we’ll focus on the most important ones here:

  • Bid/Ask spread
  • Yield spread
  • Option adjusted spread
  • Negative spread
  • Z spread

We will only discuss bid/ask spreads, yield spreads, and negative spreads as the other topics are more advanced in Kenya. Let’s discuss each one individually

What is bid-ask spread?

It’s a common question to ask about the spread in Forex because the bid-ask spreads are a popular one to find with forex brokers, and they have a convenient way for them to get payouts.

You are paying the broker for their services by the difference between the bid and ask price. So while 1 pip may seem like a small profit margin for a company in Kenya, keep in mind that the trade size determines spreads.

If you trade a lot, 1 pip equals $10, and if you trade a mini lot, it is $1, and so on. So the more you trade, the more the broker makes from spread charges.

Use the following formula to figure out how much you spend on spreads:

Lot size x (ask-bid) = payment amount.

Yield spread

Yield spreads are similar to bid and ask spreads in Kenya, but they are calculated based on different assets. Among the most common assets associated with yield spreads, bonds are the most popular asset. Here’s how they calculate them.

There will be a yield spread if there is a difference between two bonds of equal size and value. In other words, if one bond has a yield of 10% while another has a yield of 5%, then the yield spread is only 5%.

The same principle can be applied to Forex in Kenya. As an example, a high yield spread would look like this. The yield curve for EUR/USD is 20%, and that for EUR/GBP is 5%. Therefore, the yield spread can be calculated for both of these currency pairs as they are major ones.

The yield spread would be 15%, meaning more people will transfer to EUR/USD to find higher payouts.

Negative spreads

The only person who suffers from negative spreads is the broker. Negative spreads in Kenya mean you won’t have to pay commission to the broker for placing your trade orders.

Brokers guarantee that if the spread is negative, you get paid right away. However, this is only possible when you make the right call. If the currency pair begins to decline, no matter how much negative spread you have, it will not help.

Forex negative spreads usually occur when high-interest rate currencies are traded. This is because brokers gain so much profit from holding or trading government currencies that they are willing to offer their customers a higher rate of return if they use this currency pair frequently.

Fixed and floating spreads

It is misleading to call this a “type” of Forex spread because every spread in Kenya can be fixed or floating. Therefore, they are options of options when it comes to forex spreads.

The broker ensures that the spread will remain the same regardless of where the market goes in a fixed spread. The spread on EUR/USD will therefore remain the same no matter what happens.

In a floating spread, market demand is taken into account. As with the price and exchange rate of currencies in Kenya, the spread can fluctuate by increasing or decreasing. After that, the market adjusts it depending on how many people trade that pair of currencies.

Spreads vs. commissions

While forex spreads in Kenya are regarded as one of the most effective options for both brokers and traders, this does not mean that there are no alternative methods. A commission would be one such method. While spreads and commissions are usually different depending on the broker you are using, there is no reason they cannot be compared.

There are probably two key factors: the guarantee of spreads and the unpredictable nature of commissions. As a trader in Kenya, you already know what you will pay for brokerage services when the spreads are fixed.

On commissions, on the other hand, your fees will be radically different. It is possible, for instance, to grow your trade overnight, reach a deadline, or accidentally close the trade too early and pay commissions as a result.

As can be seen, bid-ask spreads in Kenya may appear more expensive at first, but the commission will have a much greater impact on your account after a while.

Understanding high and low spread

It’s important to remember that the FX spread can vary from day to day, ranging from a ‘high spread’ to a ‘low spread.’

As a result, many factors can impact the spread. These factors include volatility and liquidity. For example, some currency pairs in Kenya have a wider spread than others, such as emerging market currency pairs. This is because the major currency pairs you trade are traded in higher volumes than emerging market currencies, and higher trade volumes are associated with lower spreads in normal circumstances.

There is also that liquidity can dry up, and spreads can widen during news releases and in between trading sessions.

A widespread trend in Kenya indicates that the bid and the ask prices differ greatly. Currency pairs from emerging markets typically have a higher spread than major currency pairs.

When the spread is higher than usual, it generally means either the market is volatile or a liquidity shortage due to out-of-hours trading. Spreads can widen a lot before major news events and during big shocks (Brexit, US Elections).

Low spread

Low spreads in Kenya are characterised by a small interval between the bid and ask price. During the main forex sessions, when spreads are low, trading is preferable. A low spread typically indicates a low volatility environment with adequate liquidity.

Keeping an eye on changes in the spread

When news breaks in Kenya, market volatility is notorious. In addition, there are sporadic releases on the economic calendar that can cause price volatility depending on whether expectations are met.

Similarly, as retail traders, large liquidity providers don’t know the outcome of news events until after they’ve been released! As a result, they broaden their spreads to reduce some of their risks.

Spreads can produce margin calls

You may have your positions stopped or receive a margin call if the spread widens dramatically while you have a position open. The only way you can protect your account during a widening spread is by limiting your leverage. In times of widening spreads in Kenya, it can be advantageous to hold onto trade until the spreads narrow.

How can spreads change?

It is rare for fixed spreads to change, but floating spreads are always liable to do so. When the spread changes, there’s generally a shift in the market.

Let’s imagine that the US government announces that interest rates will increase dramatically. The news about the US dollar will likely cause forex brokers to lower the spreads on USD currency pairs.

In times of recession in Kenya, forex brokers could easily pick the best currency pair and offer the best spreads.

Why would spreads be negative?

A forex broker doesn’t necessarily keep funds on their own. Instead, they use something called a liquidity provider. Your liquidity provider is the one who enables you to trade currencies and provides you with the funds you need for your leverage.

When a forex pair has a negative spread in Kenya, the liquidity provider will likely gain more retail customers, quotas, or both. However, since negative spread options aren’t profitable for forex brokers, many refuse to display them to you.

Is floating spread better than fixed?

Not always. There are benefits and drawbacks to both. Fixed spreads in Kenya, for example, guarantee a charge of only 1 pip lot regardless of the market. On the other hand, you could potentially be charged 1.2 pips per lot or 0.8 pips per lot spending on market conditions in a floating spread.

Trading with floating spreads involves a certain amount of risk, but it can be more profitable for the trader. It is common for traders in Kenya to go with fixed spreads because they don’t have to worry about calculations.

What are the good live forex spreads?

When you look at foreign exchange spreads with major or minor currencies, you will see they are some of the lowest in the market.

Due to its popularity and wide usage in Kenya, the EUR/USD currency pair will present very tight spread opportunities because tons of liquidity providers and traders keep prices low. Therefore, the most widely-traded currencies will come with good spreads in the forex market, making them easier to trade on the market.

How to calculate spread in Forex with pips?

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In Forex, there is such a thing as a pip spread definition. The pip price in Kenya is usually determined by the service provider you are using since it’s their discretion what they charge. Let’s suppose, however, that a standard lot pip costs $10.

The spread of 2 pips means that a trader of 1 standard lot will have to pay $20 in the spread. So there would be a mini lot of $2, a micro lot of $0.2, and a nano lot of $0.02.

Can I have better spreads than other traders?

Yes, larger accounts usually get better deals on spreads than those with smaller accounts.

For example, a higher-level account would have a 1-pip spread on EUR/USD if the regular account has a 3-pip spread. Brokers benefit from this because they maintain high-level traders.

In essence, the spread is a means of generating income for brokers. However, obtaining high-level account status in Kenya isn’t easy since it takes a lot of trading volume. So whoever has the better spread conditions will earn it.

Bottom line

Unlike commissions, spreads are built into the price of an FX pair, essentially making it the main cost of the trade. Spreads are measured in pips, the movements at the fourth decimal place of a currency pair’s quote. You can calculate the forex spread by subtracting the buying price from the selling price.

Forex spreads are always variable, while other markets may have fixed spreads

The spreads can either be wide (high) or tight (low). Tighter spreads are often preferred by Kenyan traders as it makes the trade more affordable.

Wide spreads can occur in markets with high volatility and low liquidity. Conversely, a market with high liquidity but not high volatility may have tighter spreads. Spreads can change as a result of news announcements or an event causing increased market volatility.

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