Have you ever made a deal on MT5 only to see your position enter the negative zone immediately? You have already witnessed the source of confusion for many newbies: the bid-offer spread. This feeling of the market trying to charge you from the very beginning is not far from the truth.
The difference between the buying and selling price is called the spread. Once you figure out how it works, you will find many trading concepts become clear, particularly when trading with a prop firm where each pip and penny counts.
What is the bid-ask difference really?
In MT5, every instrument has always two prices:
Bid – the price to sell at;
Ask – the price to buy at.
The difference between the two is called the spread.
For instance, if we see that EUR/USD displays:
Bid: 1.1000
Ask: 1.1002
then the spread is 2 pips.
Therefore, when opening the buy position you do it at the ask price but closing it you do it at the bid price. The difference is your cost.
This does not refer to any additional fees – just an in-built cost.
The reason why beginners confuse the issue
Most inexperienced traders assume they will earn or lose their money through market movement only. However, once they open a trade, there is a cost incurred right away due to the spread.
This is especially visible in case of:
Scalping small movements;
Trading during volatile hours;
Dealing in pairs with a relatively large spread (GBP/NZD and exotics).
In prop firm trading this is especially important since the trader must be extremely precise in his calculations and a few pips can destroy a perfect deal.
A simple way to understand spread calculation
Let us start very simple here.
Spread = Ask Price – Bid Price
It may sound weird, but this value will be given in pips, rather than in terms of absolute price difference between ask and bid prices.
For instance:
Ask price: 1.2505
Bid price: 1.2500
Spread = 5 pips
Simple, right? But to really get an idea of what it means, one needs to understand the financial implications of a certain spread, especially when using larger volumes of money, i.e., position size.
Making sense of spreads
This is where people usually become much wiser about spread calculation.
Example:
Spread = 3 pips
Volume = 1 standard lot
For most common currency pairs, a standard lot means about $10 per pip.
Therefore:
3 pips * $10 = $30 for each trade made
And it suddenly sounds like not such a minor thing.
But, if the trader uses 0.10 lots:
$30 * 0.10 = $3 for each trade
This way thinking is what makes a professional. If one is trading on a prop firm account, this approach is inevitable.
How spread behaves in real markets
The other important thing to note is that spread is dynamic. It always fluctuates depending on certain market factors.
These are the periods during which spreads tend to be higher:
- Periods of major news announcements (CPI, rate announcements)
- Market opening and closing periods
- Low liquidity periods (late US session, early Asian session)
These are periods during which spreads will most likely be lower:
- London session
- New York overlap session
- EUR/USD and USD/JPY pair sessions (most liquid currencies)
In summary, even with an understanding of how to calculate spread in forex, time matters as well.
Example of a prop trading scenario
Let us consider an example within the prop trading industry.
In this case, let us say that we are using a Forex Funded Account, and we need to pass the test for an account amounting to $10,000.
Our goal is:
- To make $100 profit daily
- To risk $20 per trade
Assuming in this situation that the average spread per trade is:
$2-$4 per trade
If we execute ten trades per day, then:
We have an estimated spread cost of $20-$40 per day
Or a total of $600-$1200 monthly.
How to calculate spread properly as a beginner
In case you have no experience at all, here is how you do it:
- Check Bid and Ask prices in MT5
- Subtract Bid price from Ask price
- Translate pips into monetary terms, considering the number of lots you work with
- Evaluate the result against your projected income
The routine mentioned above falls under the notion of How to Calculate Spread in Forex efficiently.
It is more than just remembering an equation; it is all about cultivating the mindset before each trade.
Final thoughts
The bid-ask spread may seem like an insignificant element; however, in trading, every single element determines the level of success of one's activities.
The understanding of the concept of a spread allows for a trader not to perceive it as a hidden expense but rather as an integral part of their surroundings. And this is precisely where the difference between average traders and more successful ones becomes evident.
In the long run, it's not only about locating profitable trading opportunities but also about joining them efficiently and being aware of the cost required for this process.