Fixed and Floating Spreads - What You Need to Know

When it comes to trading in the forex market, spreads play a very important role. Many people don’t realize the difference between fixed and floating spreads. Simply put, the difference between the Bid and the Ask prices is the spread and this difference is calculated in pips. A pip is a basic numerical value that is used widely in the Forex market.

The value of the currency is measured in pips. One pip is equal to 0.0001, while two pips equal to 0.0002 and so on. A single pip is the smallest exchange of price that can occur on the forex market.

Most of the currencies traded on the forex market are generally priced four numbers after the decimal. For instance, a standard five pip spread for EUR/USD (two of the most popular currencies) is generally 1.2530/1.2535. On the other hand, there are certain major currencies that do not have four decimal places after the point. Instead, some pairs, such as the USD/ JPY pair, only has two places after the decimal. The pair generally looks like this: 114.05/114.08. As you can see, there’s a three pip spread between the selling and the buying price.

What’s a Spread?

The spread highlights the difference between the price that the market maker gives to the trader, as well as what the market maker collects to sell it off to a trader. If you buy any pair of currency and sell if off without any change in the values of the currency, the trader ends up losing money, because the bid prices always fall below the ask prices.

Therefore, it stands to reason that smaller spreads are much better for forex traders. The reason for that is obvious: a small movement in the exchange rates can allow the trader to profit considerably form a trade in a much easier manner. Now, in general, there are two types of spreads: fixed and floating.

Fixed Spreads

As you can already guess, fixed spreads do not fluctuate with the passage of time. They are also not influenced by market volatility or the standard fluctuations in the market. However, the spread may change temporarily in case of high volatility and low liquidity, but the change is not massive and is only shifted to a different spread level. As soon as the market returns back to its original position, the spread automatically reverts back to its original position.

Floating Spreads

A large majority of spreads on the forex market are floating spreads. They tend to continuously fluctuate based on the volatility in the market and the general fluctuations. A number of companies offer trading on floating spreads as well as almost all relationships between international banks are defined by floating spreads. Moreover, floating spreads are generally where people tend to make more money, as there’s considerably more unpredictability with floating spreads.

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