What Is the Spread? The Truth About Trading Costs That Can Cost You If You Don’t Know It
One concept you can’t avoid when trading FX is the “spread.” Many beginner traders tend to overlook it, but in day trading it is an important factor that can make or break your profits. In this article, I’ll explain everything from the basics of the spread to what to look for when choosing a broker, and how the spread affects technical trading.
The Basic Concept of the Spread
The spread is the difference between a currency’s buying price (Ask) and selling price (Bid). Brokers basically earn their revenue from this spread. For example, if USD/JPY (US dollar/yen) has an Ask of 100.05 yen and a Bid of 100.03 yen, the spread is 0.02 yen (2pips).
In other words, every time you trade, you start in the red by exactly that difference.
How the Spread Affects Your Profits
Especially in short-term trading such as day trading and scalping, where you build up profits from small price moves, the size of the spread directly affects your profitability (win rate).
For example, if you make 5 trades a day, each aiming for a 10pips profit:
- With a 1pip spread: actual profit is (10-1)×5 = 45pips
- With a 3pip spread: actual profit is (10-3)×5 = 35pips
Even with the same trading strategy, the difference in spread can change your final profit significantly.
Spreads Differ by Broker
Spreads vary widely from broker to broker. In general, they have the following characteristics.
1. Fixed Spreads and Variable Spreads
Fixed spreads:
- The spread stays constant regardless of market conditions
- Trading costs are easy to predict
- It doesn’t change even when the market gets volatile
- Usually somewhat wider than variable spreads
- Rather than being completely fixed, they are often “fixed in principle (with exceptions)”
Variable spreads:
- They change depending on market liquidity
- Very tight under normal conditions
- They can widen sharply during major data releases or low-liquidity hours
- Costs are hard to calculate
If you mainly do day trading based on technical analysis, most of your trades take place under normal conditions, so variable spreads will often be the better choice. However, you need to be careful around major data releases, in the early morning hours, and during quiet holiday periods.
2. Spread Comparison for Major Currency Pairs
It varies by broker, but typical spreads (under normal conditions) for the major currency pairs are as follows.
- EUR/USD: about 0.1–0.7pips (the tightest)
- USD/JPY: about 0.2–0.8pips
- GBP/USD: about 0.5–2.0pips
- GBP/JPY: about 1.0–3.0pips
If you trade at high frequency, as in scalping, it’s important to choose a broker with even slightly tighter spreads. Yen crosses like GBP/JPY in particular tend to have wider spreads than the major pairs, so choosing the right broker matters even more.
The Relationship Between Spreads and Commissions
Broker revenue models fall broadly into two types.
1. Spread-Only Model (No Commission)
- Spreads are relatively wide
- No separate commission
- Total costs are easy to understand
- Common among Japanese domestic brokers
2. ECN Model (Commission-Based)
- Spreads are very tight
- A separate commission is charged
- Total cost = spread + commission
- Common among offshore brokers
Which one is better depends on your trading style, but if you frequently day trade using technical analysis, it may be better to choose the ECN model with its lower total cost (spread + commission).
Currency pairs are explained in detail in the following article.
Tips for Keeping Spread Costs to a Minimum
1. Choose When You Trade
Spreads change with market liquidity. In general, spreads tend to be tighter during the following hours.
- USD/JPY: when the Tokyo and London markets overlap (around 3 pm–5 pm JST (06:00–08:00 UTC)), and when the London and New York markets overlap (around 9 pm–1 am JST the next day (12:00–16:00 UTC))
- EUR/USD: when the London and New York markets overlap (around 9 pm–1 am JST the next day (12:00–16:00 UTC))
- GBP/JPY: the core hours of the London market (around 4 pm–1 am JST the next day (07:00–16:00 UTC))
2. Avoid Major Data Releases
During major data releases such as NFP (nonfarm payrolls) or the FOMC (Federal Open Market Committee), spreads can temporarily widen sharply. Especially at brokers with variable spreads, it’s not unusual for them to reach 5–10 times their normal level or more.
When trading based on technical analysis, it’s important to either avoid these times or make sure you don’t hold a position going into the data release.
3. Choose the Right Broker
If spreads are a priority for you, compare brokers on the following points.
- Spreads on the major currency pairs
- Variable or fixed
- Whether commissions are charged
- How often slippage occurs
- Fill quality (especially during sharp market moves)
That said, don’t choose a broker on tight spreads alone; it’s important to make an overall judgment that also considers things like withdrawal speed and customer support.
How to Account for the Spread in Technical Trading
In the technical-analysis-based day trading covered on this site, it’s important to build trading strategies with the spread in mind. Specifically:
1. Set a Minimum Profit Target
For example, if the USD/JPY spread is 1.0pips, set a rule to aim for a profit several times the spread, such as at least 10pips. This lets you fully cover the trading cost of the spread.
2. Include the Spread in Your Risk-Reward Calculation
In technical trading, you calculate the risk-reward ratio (the ratio of profit to loss) before entering. When doing so, it’s important to calculate the actual risk-reward ratio including the spread.
For example, even if you aim for a 10pips profit with a 5pips stop loss (risk-reward ratio = 1:2), a 3pips spread lowers the actual risk-reward ratio to 7pips:5pips = about 1:1.4.
3. Balance Trade Frequency and Spread
When you trade very short-term and frequently, as in scalping, even a tiny difference in spread makes a big difference. On the other hand, in swing trading where you hold positions for several days or more, you can sometimes cover a somewhat wider spread by targeting a larger room to run.
Choose the broker and trading strategy that best fit your own trading style.
Summary: Understand the Spread and Trade Smart
The spread could be called the “hidden cost” of FX trading. Especially in day trading based on technical analysis, you need to fully understand this cost and have a strategy to keep it to a minimum.
- Choose a broker with tight spreads
- Trade during high-liquidity hours
- Calculate risk-reward ratios with the spread taken into account
- Choose a trading cost structure that suits your trading style
By keeping these points in mind, you can cut unnecessary spread costs and make your trading more efficient. To make consistent profits in day trading, this kind of careful cost management is also an important factor for success.
Next time, I’ll cover “The Trap and Appeal of Leverage – Mastering FX’s “Double-Edged Sword”.” Let’s learn how to properly understand and effectively use leverage, one of the defining features of FX trading.
