What is a Spread? | Definition and Example


Spread is the difference between the bid (buy) and ask (sell) prices of a financial instrument, such as stocks, currencies, or commodities. The smaller the gap between these prices, the better for traders because it means lower costs. On the other hand, a larger gap means higher costs.

Spread in a nutshell

  • Spread is the difference between bid and ask prices of financial instruments.
  • The spread is the transaction fee that brokers earn without charging additional commissions.
  • Binary options trading doesn’t involve spreads; prices are determined by market consensus.

What are the two price types in Forex Trading?

Whenever a forex broker quotes prices for a currency pair, there are mainly two types of prices they can refer to. One is the bid price, and the another is the asking price. You can sell the base currency at the bid price. At the same time, a trader can buy the base currency with the asking price. The difference between the bid price and asking prices is called ‘spread,’ also known as ‘bid/ask spread.

Therefore, if a customer wants to sell a forex pair or currency pair, the price quoted by the broker is the bid price. When customers wish to start to buy trade, the asking price would be quoted. 

Forex pairs or currency pairs are quoted with two different currencies, such as US dollars versus Canadian dollars (USA/CAD). The base currency is also known as the first currency. However, the second currency is called quote currency. So, the currency pairs stand for base/quote currency. 

Spread is the way how ‘no-commission traders’ earn profits. Moreover, the spread is the transaction immediacy fees that must be provided. Despite making a separate fee, spread cost is built into your purchased currency pairs’ buy and sell price. That’s why the brokers do not ask for the extra commission. 

The small price movements which can measure the price variation are called pipsPips are a change in the fourth decimal position of a currency pair or the second decimal position, while trading pairs are considered in JPY. So, across most currency pairings, one pip equals 0.0001.

Example: How does the broker earn spread?

For instance, if an investor intends to purchase EUR/USD on the broker’s trading platform, and the bid-ask price is $1.17673/1.17675, the broker earns a spread of $0.00002. How? Let’s delve into it.

To initiate a buy trade, the investor would pay the asking price of $1.17675. Conversely, if the individual decides to immediately sell back the euros to the broker, they would receive a bid price of $1.17673 per euro. Hence, the broker’s commission or spread in this particular transaction amounts to $0.00002.

In most currency pairs, one pip equals 0.0001. Therefore, in this case, the spread would be equivalent to 0.2 pips.

With a spread of 4 pips, trading quotes can be indicated. However, if you want to quote a currency pair in Japanese Yen, the calculation spread will be different as Japanese Yens can be quoted only for two decimal places. For example, if a USD/JPY currency pair is 110.00/110.04. 

Is there a spread in Binary Options Trading?

No, there is no spread in binary options trading. Binary options operate on a yes/no premise, with fixed payouts and expiration times. Instead of spreads, binary option prices are determined by market consensus, reflecting traders’ beliefs about the likelihood of specific events. Traders pay a fixed upfront price to purchase a binary option, representing their maximum potential loss if the event doesn’t occur. Conversely, if the event happens, traders receive a predetermined payout.

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About the author

Marc Van Sittert
Marc Van Sittert is an experienced Binary Options Trader and coach who is originally from South Africa. He started his career in 2014 by trading old-school Binary Options online. His main focus is on short-term contracts with 60-second trades.

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