Most of the Newbies in forex trading is asking; What is pip and spread?
For people who love challenges, forex trading can be one of hundreds activities that attracts their interest. Why so? Forex trading is not just a trading, it requires meticulous observation to the market where you buy and sell the currency, patience to wait for the right moment to make a move, and even a quick thinking to decide what you should do. When you have been accustomed to how the trading works, it is easier for you to get lots of profit. And to help you to be an expert like that, you can start it from the basic things about Forex which is pip and spread.You are not going to find the precise definition on pip and spread in a dictionary for they are special terms to use in Forex trading. But it does not necessarily mean that pip and spread are hard to understand. Just take your time and learn as much as you can from here.
Right, pip and spread seem to be inseparable since whenever you read about spread, you will soon see the term pip mentioned after that, or vice versa. Although commonly discussed, remember that they are not the only key for traders to obtain the maximum profit from the trading. There are many other factors for that. But you cannot deny either that knowing well what they are and how they work do help you to do better and therefore you are not going to experience terrible loss, at least at the beginning of your journey to be a top trader. For newbies the guarantee that they will not lose their money too much is a motivation to practice more and improve their capability as a Forex trader. You see the importance of knowing the two things, don’t you?
What is Spread
Let’s start our journey to Forex trading from the term spread. If you look it up in the dictionary, you will see that spread is defined as the difference between prices at which something is bought and sold, or the interest rates for lending and borrowing money. That is exactly what is said by the dictionary. In Forex trading context, will the definition far different? Fortunately, it is not. A reliable sources for this matter defines spread as the price between where a trader can buy or sell an underlying asset. Usually, the difference is not very dramatic, however, still it does matter in trading for there is multiplication. It is quite easy to understand from here on what a spread is. One more thing that a newbie has to always remember is, spread does not stay still. This means that spread will change sporadically with some factors affecting it, such as liquidity and upcoming economic data. Now, it is the time to move further on how a spread works and what it tells you in Forex trading.
Take an example, you will see the buy price for EUR to USD is at 1.35640 and the sell price is at 1.35626. Subtract the buy and sell price and you are going to find .00014 as what you are left with. This is the spread or the difference between the price you buy and sell the currency.
This is not the end, however. After knowing the spread, you should also know the pip value of it and this is exactly the reason why you must know well about this term. Are you ready to move from spread to pip? Let’s check it out!
What is Pip
While spread talks about the difference between buy and sell price, pip is the smallest price change which a given exchange rate makes based on market convention or behavior. The most major currency pairs are priced to four decimal places and therefore, the smallest change is in the last decimal point. Not all pairs apply this, but mostly it is the equivalent of 1/100 of 1% or one basis point. A pip varies based on how a given currency pair is traded and the value of one pip can have completely different values depending on the pair and pricing condition.
Talking about pip value, you can go back to the previous example of spread. You see that you get the difference of buying and selling price in .00014 point. For the pip value is identified by the fourth digit after the decimal, then it is calculated as 1.4 pips.
Besides pip itself, you may want to know how Forex traders call 5 pips. In a slang term, 5 pips or 5 basis points is called nickel. This is equivalent of 0.0005 or 0.05%. Hopefully you are not getting confused with the term pip and nickel. It is not a problem for you to focus on understanding pip first, because you want to be the master of trading who definitely know even the smallest thing of the trade, right?
You are now done with pip and spread. As time passes, you as a newbie will have a lot better understanding towards them as you practice more and more. And before you start your Forex trading, it is good for you to read a little bit about some tips to be a successful trader:
- Know what you need. Every trader has their own risk tolerance because their needs is not the same. Do not be distracted with what other trader is doing that they use more money than you or they take a bigger risk than you.
- Choose your broker carefully. You can work by yourself with the pip and spread, but later. As a newbie, it is a better idea to have a broker who helps you with your trading at least at the beginning. Read some reviews on the most reliable Forex brokers to get the most suitable one.
- Focus on single currency pair. It looks cool when you can trade with pairs of currency, but again, later. As your skill improved, you can do that. For the near future, let’s play safe and focus only on single currency pair. Good luck, newbies!
- Better Pricing: FX quotes are a direct reflection of interbank market prices
- Narrower Spreads: Most brokers operating under this process offer spreads as small as 1.5 pips to 2 pips on major pair transactions
- A Better Feel: Variable spreads offer insight into market conditions. If spreads are narrow, there is plenty of liquidity to be had. However, if spreads are wide, all-around execution may not be as good as it is with light volume in the market
- Fluctuating spreads means that the costs of entry can vary. Sometimes the retail trader will pay two pips, while others can pay five pips, depending on market conditions
- Variable spreads mean that some strategies will be thrown out the door as stop and limit orders are subject to price availability and fixed spreads on charts