How to take into account the spread in Forex when opening and closing trades

Hello, friends! This lesson will be aimed at the novice forex traders who hurry to make millions, forget about important details that make up the trading on the Forex market. We’ll talk about the spread, why at the opening of the position you see two prices (Bid and Ask), and most importantly - how to take into account the spread size of the opening and closing orders on Forex.

Sometimes newcomers resent, write to a broker’s tech support “Why I opened the transaction, and it was immediately in the loss? Price did not move. Why?” or: “A trade opened, profit or stop loss triggered, although there was no such a price on the chart? Is someone cheating me? What’s the matter?” or: “Pending order had been activated, although the price has not yet reached the level of a pending order.” Answers to these questions lie in the concept of the spread.

What is spread?

Let’s go directly to the trading platform and see in practice what is spread and how to take it into account when trading. Suppose we have the euro dolar chart. Currency pair - EURUSD. And we can see on the chart the current price: 1.0929. If we click on “Open new order”, we will see that we have two prices - the price at which we can sell (this price is called Bid), and the price at which we can buy (this price is called Ask).

Why 2 prices, as there is one price on the chart? In this case, a comparison with the currency exchange helps a lot. I think everyone at least once used the services of currency exchange point to change euros for dollars, euros for francs or some other currency. The bank always gives 2 prices. The price at which you may buy the currency, and the price at which you can sell your currency.

And the price at which a bank can buy a currency from you is usually slightly lower than the official rate of the Central Bank. And the price at which bank can sell you the currency is a little bit higher than the official rate of the Central Bank. Why? Because the bank earns on this difference. Every time by selling you the currency a little bit more expensive and buying it at a little bit lower price than the official exchange rate, the bank earns money.

Similarly with Forex. The difference between the prices at which you can sell and for which you can buy is nothing else than the spread. And this spread comes to your broker as a commission, the broker earns a spread. If you can earn 40 points, lose 10, earn 500 points (depending on your forex strategy and how you are trading), the broker always earns on each of your transaction a flat fee.

Broker’s Earnings

Spread depends on the currency pair. For some currency pairs, it is smaller, for example, on EURUSD, as this currency pair is very popular and has high liquidity. In some exotic currency pairs, like dollar - Mexican peso the spread, naturally, will be much higher, because the demand and liquidity of these currency pairs are much smaller.

Every time you open or close a deal, a broker earns on the spread from part of a point to several points. When you buy, the broker earns at the opening of the transaction, so you buy at a price slightly higher than the market. When you sell, the broker earns at the close of the transaction.

Please note that once you have opened a buy order, it is already in a small minus. This is because we bought at a price slightly higher than the market. Similarly while selling, but there the spread is taken at the moment of closing of the transaction (see below).

Spread when buying and selling

Accordingly, as soon as we close the deal, we will earn something or lose something. The broker has already earned at the time of opening of the transaction, since he allowed us to buy a currency pair slightly more expensive than the market value, and accordingly, put the difference in his pocket. And our task is to earn our points. And their number will depend on your trading, your style, and strategy.

Please, note that we are selling at a price that is on the chart (it is the same as the bid price). And we close the position at the market price, at the Ask. So, we will pay the spread in any case. But when you open a buy position, we pay it at the time of opening, in the case with sales spread is charged when we close the deal.

Spread when setting take-profit and stop-loss: Buys

If you have some big goals, big stop-loss orders, large take profits at 100-200 points and above, you may not pay any attention to the spread. Since it is too small compared to your goals. If you are trading on the daily charts, you have large takes and big stops the spread can be completely ignored. It won’t make a big difference. And if you have small goals, you are trading intraday and take the profits of 10-20 points, the spread is worth paying attention to.

First, let’s consider buying. It is quite simple for purchases. It should be borne in mind that we do not buy at the price that was on the chart, but slightly more expensive. And if you have some sort of signal on the chart by your system, you measure out the targets, not from the signal (for example, take-profit 20 points), but from the point of which you bought, ie. slightly higher on the chart.

Thus, when placing take-profit on the purchases we add to the point where we have a signal, our take profit plus spread. For the euro-dollar pair, the spread is very small, often less than 1 point. It may not be taken into account. But on pairs with a higher spread, 2-3 points, those points should be added to the take profit.

And if you put off some distance from the signal emergence point, then it will not be 20 points, but 21, for example, that is you add spread size to your target. Stop-loss should be measured off from the point where you have a signal, N number of points that corresponds to your stop-loss (for example, 20 points). And you set the price value at which you should have a stop-loss.

As you can see, with buying it’s simple. Please, note that if you place a pending buy stop order, then your pending order will work out just before the price reaches this level on the chart that you set as buy stop.

Buy Stop is activated just before the price reaches the level of a pending order on the chart (with a difference of spread size, as we always buy at a price higher than on the chart). And when the price reaches the spread size on the chart, the level of our pending order, the order is activated. This should be taken into account.

Spread when setting take-profit and stop-loss: Sales

Let’s now look at the sales. When we sell it is to our advantage that the price goes down. We have to limit our possible losses with stop-loss.

Please note that our stop loss in case of sales is activated slightly earlier than the price reaches its line. Why? All the same as with the pending orders for purchases. We buy, and by closing the sale, we actually buy at the Ask price, at a price slightly higher than the market price. Therefore, when the price is at a spread distance from our stop loss, it will be activated.

Keep this in mind. If you do not want your stop-loss to work out on sales because of the spread, you should set it a bit higher (at a spread distance) in sales. We add the spread value to the stop-loss and set it a little higher: half a point, 2-3 points, if your spread corresponding to a certain currency pair has this value.

What to do with take-profit? Well, we set take-profit below the market price, because we sell. It is activated for the sales just below the take-profit line that you can see on the chart. After all, the price at which the order will be closed - is Ask price, and it is slightly higher than the current price on the chart.

Sales order will be closed at the Ask price, the price at which we can buy. Therefore, our take-profit will work slightly below our take-profit line on the chart (at a spread distance). For your sale, the current price is the current price + spread. It is higher on the spread value. And when the price on the chart reaches this line, you will need just half a point to spread in order to activate the take-profit of your sale.

If you set a sell stop pending order below the current price, then it will work when the price crosses the level of your pending orders on the spread value. It is also worth taking into account.

Spread Extension

Also, please, note that if you have an ECN account, spread extension is possible on it. Most of the time spreads are low, it is an advantage of this type of account, but at the time of economic news release spreads extend and can activate your stop-loss, take-profit or pending order, although the price has not reached it due to spread extension. You should understand it and take it into account. Simply put, do not trade on the news and everything will be fine.

Conclusion

So, let’s summarize our lesson. Orders executed at a Bid price: Sell, Sell limit, Sell stop, Stop-Loss and Take-Profit for a buy position.

Orders executed at an Ask price: Buy, pending orders Buy limit, Buy stop, Stop-Loss and Take-Profit for sale’s positions.

Take care, Michael

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