Forex Trading – What Is Market Spread in Forex?
Spread is the difference between the bid and the ask prices of money pairs. Currencies get traded in pairs like EURUSD, GBPUSD, USDJPY etc. Suppose, EURUSD bid price is 1.3453 and the ask price is 1.3456. What this method is that if you want to sell EURUSD, you will get the rate 1.3453 and if you want to buy EURUSD, you will get 1.3456. So, you will always pay more to buy a pair and get less when you sell that pair. The trader placing the order demands liquidity and is willing to pay a certain spread for that. While the market maker supplies the liquidity in the shape of charging the spread. This is the basis of the bid ask spread.
Forex market developed after the collapse of the Bretton Woods System in 1973. Currencies became free floating and exchange rate instead of being fixed was subject the market forces of need and supply. Today, Forex market is the largest global market where more than $3 trillion of currencies get transacted daily.
The main force behind the development of the money market is the rise of international trade and finance. Over the past many decades, the global economy has become highly interlinked. Large edges and corporations need to exchange currencies. Countries make huge imports. This requires the payment of foreign money to the exporter.
Almost all the countries import oil. In order to import oil, they need to transform their local currencies into US Dollar as USD is the main money in which oil is bought and sold. In the same manner, countries need to import coffee, coca, soyabeans and other commodities for local use. This requires conversion of local money into foreign money. The rate you get is based on the supply and need for that money in the international market.
Multi nationals have their operations spread all over the world. They need to pay their employees and repatriate profits. in any case, these huge money transactions by the central edges, large edges, corporations, hedge funds and other big dogs sets the stage for a huge global over the counter money market where big players pay for the foreign money in terms of their domestic money.
Now, unlike other markets, the money market is segmented. At the top is the Interbank Market. This is for the big players, like very large edges and large institutions and corporations. They make huge money transactions. The interbank market has the lowest spreads as the money transactions are huge.
Below the interbank market comes the dealers and market makers for the retail market who need a certain additional spread for supplying liquidity to the small traders. So, in the retain market, you will get a spread that is a few pips more than the interbank market.
As the Forex market is unregulated, this spread can vary from one dealer to another. So, you need to be careful and choose only that broker that supplies the best spread to you as spread in the long run is your trading cost and you need to keep it low. Good Luck!