Defining a trader’s profit and loss balance is an essential component of trading; in order to do this, the trader needs to take a look at the pip, and spread factors in the equation. A pip defines the smallest price change, or fluctuation, that an instrument can make. In the Forex market, currency pairs are usually priced with a total of four decimal points; therefore a 0.0001 change equates to on pip – for Yen pairs, which are stated in two decimal points, one pip equates to 0.01.
EUR/USD climbing from 1.3500 to 1.3400 reflects a 100-pip rally
Whereas a drop in GBP/USD from 1.3450 to 1.3400 indicates a 50-pip slide.
USD/JPY rising from 94.50 to 95.75 translates to a 125-pip climb
Whereas a drop in AUD/JPY from 78.50 to 76.00 means a 250-pip selloff.
Meanwhile, spread is the difference between the bid, and the ask price. The bid price refers to the rate at which a broker (or market maker) is buying from the trader; and the ask price is the rate at which the broker in question (or market maker) is selling to the trader. The bid price is generally set lower than the actual market rate.
For instance, if the spot rate of EUR/USD is 1.3450, a broker can quote the bid at 1.3455 and the ask at 1.3445, amounting to a bid-ask spread of 10 pips. A bid/ask quote for EUR/AUD at 1.4500/1.4520 translates to a spread of 20 pips. Wider spreads can erode trading profits or magnify losses which is why narrow ones are often preferable.
When a trader calculates their potential profit/loss (most probably to observe the risk/reward ratio, in order to define how worthy a strategy is), they should bear in mind not to forget to apply the correct prices since the spread also impacts the bottom line profitability, especially for day traders which open multiple positions in a day. These spreads also apply to stocks, commodities, indices & futures.
Please note: spreads may also widen for some brokers, depending on market conditions; in such cases, slippage may occur and cause a trade to be executed at different prices than what was indicated in the stop, or limit orders. Such scenarios are often seen during releases of top-tier reports, session overlaps, central bank announcements and more. Other brokers, however, are able to offer fixed spreads.
With regards to this, it is necessary to compare spreads being offered by brokers before deciding to open a trading account. It also aids to practice with a demo account of a broker in order to see the spreads which are integrated in the trades. While some can offer narrow spreads during normal market conditions, widening spreads in volatile situations may also be damaging to the profitability so that traders could prefer fixed spreads instead.
Forex Tigon LTD offers highly competitive [fixed] spreads on the various instruments which are provided; namely Forex, commodities, and indices. Such offers ensure the transparency of brokers, without having to worry about additional costs from slippage; this way, the trader will also be able to calculate the potential risk and reward ratio on the go, since the price that is clicked, is the price that the trader will receive. Inherent risk is included with regards to any investments that you may want to make – especially with trading; traders must ensure that they understand all the costs and risks of trading before deciding to indulge in such activities.