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Understanding Forex Spread Requires Knowing The Dual Meaning of the Term Spread

February 20, 2012 | Comments: 0 | Views: 129

To understand what a Forex spread is you need to understand that in the realm of Forex, there are two totally different things the word spread refers to. For one thing, a spread in any type of commodities market is a trade made where the trader buys one commodity and at the same time sells another. When making this type of trade it is not important if both of these commodities rise or fall in price. The only thing that is important is whether the difference between the two increases or decreases. In this article, we will expound on this meaning of the term and explain the other meaning of the word spread as it applies to the Forex market.

The term spread has been used for decades when describing a trade of two different entities at the same time. In commodities futures trading, a speculator will many times buy one contract month and sell another contract month of the same commodity. For instance, he may buy August Live Hogs and sell December Live Hogs.

The beauty of making such a trade is the fact it has very little chance of turning too far against you. With the spread mentioned above the speculator may see an urgent need for life hogs in the late summertime and see relief may be coming in the offing months. When this happens, the near months will rise in relation to the far off months. However, if it doesn't happen this trade can very rarely turn too violently against the speculator. At least, this is what past history has taught us.

In the Forex market, all currencies are traded in spreads or what are also known as pairs. For instance, EUR/USD and GBP/JPY are both currency pairs that are actually traded as spreads because one currency is bought against the price of another. However, there is another type of spread that is prevalent in the world of Forex market trading.

Forex pairs can be bought at the price someone is asking and sold at a price someone has bid. So you can see, with Forex pairs, there are always two prices quoted. The first price quoted will be the bid price and the second price quoted will be the price asked. As an example, the bid /ask price on a EUR/USD pair may be listed as 1.3100/04. This means the price you could buy this pair for would be 1.3104. However, if you were trying to sell this pair the price you could get at this moment would be 1.3100.

The difference between the bid price and the asked price is the spread. It represents the broker's commission. So, if you were to buy a EUR/USD pair as quoted and sold it immediately, you would lose.0004 or what is also known as 4 pips. This would be the commission you paid for doing this trade.

It is probably not necessary you understand the relevance and history of the word spread the way it has been used throughout the world of commodities trading for the past many years. However, it is necessary you understand there is a difference between the price asked and the price bid on a particular Forex currency pair because essentially this is commission you are paying and this spread is actually a part of your trading expenses.

The author of this article, Ed Lathrop, is a certified commodities futures broker having passed the Series 3 National Commodities Futures Exam in 1993. Visit his Free website, Forex Trading System Secrets which has been called the number 1 Forex resource on the net. Also, get free up-to-the-minute Forex quotes, charts and other resources at Daily Forex Signal.

Source: EzineArticles
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