Forex Commissions and Spread Guide
For those just entering the market, forex can be very confusing. How do forex commissions work? What are forex spreads? If understood correctly, forex trading features a major benefit when compared to other forms of trading: low commissions and fees. In this forex commissions and spread guide, we break down all the technical aspects so you can get started in no time.
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Forex and risk – these two terms are so often paired together they might well be the equivalent of the investor’s PB&J….with a hefty garnish of fine print disclosures.
But does forex trading always have to be so risky? Is there a way to hit the ground running, rather than just hitting the ground and ending up in the red?
The greatest risk you will ever encounter when trading forex is your own lack of knowledge. When you know what you are doing, are committed to learning continuously as you go and take it seriously – both the potential risks as well as the potential rewards – that is when you begin to be able to control your own exposure (risk) and have a chance to make some real profit.
The key to getting to this point is to understand the nature of forex transactions and how brokers make money when you trade forex. To do that, you need to understand – and we do mean fully understand – forex spread and commissions.
If you have been doing some researching on your own you have probably noticed terms floating about such as “high spread,” “low spread,” “fixed spread,” “variable spread” and even “zero spread.” What this tells you is that there are different types of spread.
Another common question is the following: Does forex have commissions? The short answer is yes, as this isn’t so simple either.
Forex commissions are often (but not always) tied to forex spreads. What this tells you is that forex commissions can vary. It also tells you that it is important to pay attention to both spreads and commissions to keep broker fees from eating up your profits.
So what are forex spreads? What are forex commissions? How do they work – separately and together – to impact your bottom line when trading forex?
What Does Spread Mean in Forex?
For anyone who may be reading this article who is brand new to forex transactions, it is critical to start with an accurate picture of what you are trading – currency pairs.
Understanding Forex Currency Pairs
Trading forex is always based on currency pairs, such as USA/GBP. Here, the United States dollar is paired with the United Kingdom (Great Britain) pound.
For the purposes of our example here, let’s say you are a United States citizen and you are interested in trading this currency pair.
Brand new to forex? See our beginner’s guide to forex trading.
What do you need to know to get started?
The first thing you need to know is what USA/GPB itself is telling you.
- The “USA” part is telling you that the base or transaction (domestic) currency is the U.S. dollar.
- The “GBP” part is telling you that the quote currency is the GBP pound, i.e. the foreign currency you want to buy.
The base currency will always appear first and the quote currency will always appear second in a given forex currency pair.
Why do forex transactions always include a pair of currencies?
This is because forex traders (you and your counterparty) are buying and selling currencies at the same time. Using our USA/GBP example, here you would be selling U.S. dollars and buying G.B. pounds.
Where Is the Spread?
When you look at a currency pair, you will see some annotations next to each currency. On the left (near the base currency) will be the SELL price. On the right (next to the quote currency) will be the BUY price.
In most cases, these two numbers will not be the same.
Taking our USA/GBP example from earlier, let’s say you are looking at the following:
- USA: 1.13398 (this is the “bid” price)
- GBP: 1.13404 (this is the “ask” price)
The difference between these two numbers is 0.00006. This is what is called the “spread.”
You can think of the spread from here forward as the cost of making a forex trade.
The spread number can also be written as 0.6. But when written this way, it is called a “pip” (the word pip stands for point in percentage).
A pip is a measurement of the very smallest possible change in price between each currency in the pair. One pip is the equivalent of 1/100th of one percent. So this is a very, very small price change.
A pip is actually one way to explain the spread or difference in price between each currency in a given pair.
Simply put, the pip tells you how much of the base currency you need to spend to purchase a single unit of the quote currency. The wider the spread, the more of the base currency it will take to purchase a single unit of the quote currency.
This is why forex can be so risky – because what appears to be a relatively simple transaction at first glance can become very complicated very quickly.
And there is a lot more to learn when it comes to navigating how a change in either side or both sides of the currency pair can impact the profitability of your trade (or lack thereof).
How do Forex Spreads Work?
Now that you have a good basic understanding of what a forex spread is and how to find it, let’s dig deeper to look at the different types of forex spreads.
There are two basic types of spreads: fixed and variable (floating).
You may find one or both types depending on which type of forex broker you choose to work with. For our purposes here, suffice it to say that market maker (dealing desk) forex brokers are more likely to offer fixed spreads while non-market maker (non-dealing desk) forex brokers are more likely to offer variable spreads.
So, how are spreads calculated? This is done by subtracting the bid price from the ask price. See the following image for an example:
Fixed spreads do not change no matter what the market does. The reason market makers offer fixed spreads is because they are acting as the counterparty (buyer to your seller and vice versa).
Because the market maker is the counterparty, they are responsible for notifying you if the spread changes before your trade order is submitted. They will do this by means of a notification called the “re-quote.” A re-quote simply alerts you of the change in price and requests your permission to proceed (or not) with the trade at the new price.
Sometimes the prices are changing so quickly your broker literally can’t keep up with sending out the notifications before your trade order goes through. When this occurs, it is called “slippage.” No forex trader likes slippage. It can cost you a lot of money and is a frequent topic of forex trading learning tools.
A word to the wise here: many brokers will tout “zero slippage” as one of the perks you will get for choosing to trade with them. But be aware it is very difficult to find a broker who can truly offer zero slippage!
These ever-present issues aside, forex newbies also often assume fixed spread pairs are less risky than variable spread pairs. The word “fixed” makes them sound less risky. But actually, the only less risky aspect is the amount of capital you need to get involved – you don’t need to spend as much to trade in fixed spread currency pairs.
Otherwise, there are pros and cons to trading each type of currency pair and one is not less risky than the other.
Variable Spread: Why Forex Spreads Change
If fixed spreads are the vanilla of the forex world, variable spreads are the chocolate (or chili pepper). Have you ever wondered why forex spreads change? Well, when the market moves, the variable spreads move.
This can happen a lot. It will be up to you, the trader, to implement your own controls to ensure you don’t place a trade and have the spread change drastically on you mid-trade.
However, slippage can still occur even with controls in place.
As its name suggests, a high spread simply means that there is more difference between the base currency (bid) price and the quote currency (ask) price.
Sometimes a high spread is also referred to as a wide spread.
A low spread means that there is less difference between the base bid price and the quote ask price. Sometimes a low spread is also referred to as a tight spread.
Zero spread is not common and you probably won’t find it with any of the major U.S. regulated and licensed forex brokers. But it is out there and thus you need to know about it.
Given that we just explained that spread itself is basically the cost of making a forex trade, it might seem like zero spread trading is “free” forex trading.
What you need to know up front is that trading in zero spread pairs does not equate to free forex trading (although that is what some less up-front brokers would love for you to assume).
What it means is that you will pay for the trade via broker commissions rather than via spread.
Which leads us to the second part of our discussion here – what are commissions in forex?
What Are Forex Commissions?
Forex commissions are fees assessed by forex brokers. While sometimes the word “commissions” and the word “spread” are used interchangeably, as you will see, they are not always one and the same.
Commissions can be assessed as pure spread. But they can also be assessed in addition to spread.
When this happens, it may simply be that the forex broker is charging an extra commission for using the platform, for providing extra education, for offering access to human financial planners or for some other service.
Commission structure is another major area where different forex brokers try to attract new customers by stating their fees are lower than you will find with other brokers. For your own safety and profitability, always do your own due diligence here.
It is very smart to read through all of the fine print (even the really boring parts) in advance before you choose a forex broker so you fully understand how that broker makes money when you trade with them.
Not 100% sure what a forex broker does? Review our guide to forex brokers.
How is Forex Commission Calculated?
Typically, there are three basic types of forex commissions: fixed, variable and percentage.
A fixed commission is tied to the degree of spread between the two currencies in a given pair.
A variable commission is also tied to the amount of spread present when a forex pair is traded.
A percentage commission is set by the broker and tied to the degree of spread. But this is a smaller commission that is just a percentage of the actual degree of spread.
Usually percentage commission forex trades are only available when a broker has a relationship with a larger broker with greater liquidity that deals in high-volume forex trades.
Another type of percentage commission you might encounter is a small extra fee assessed in exchange for extra perks, such as additional trading education, proprietary software, real-time market reports and news, et al.
How Forex Brokers Make Money from Spreads and Commissions
Now you have a working knowledge of forex spreads and commissions, their similarities and differences and the basic types. How forex brokers make money from spreads and commissions can and does vary from one broker to the next.
Market maker brokers typically earn their keep through fixed spreads. Non-market maker brokers earn income from variable spreads. Both types of forex brokers may also assess commissions, although this is not always the case.
Forex brokers that have a straight commission structure may also earn money by the number of trades they place. This is where you are more likely to see percentage commissions popping up.
Forex brokers that offer zero spread forex trading will always assess commissions that are tied in some way to the volume of trades you place. These commissions may change based on certain trade volume minimums and other similar criteria.
The topic of how forex brokers make money from spreads and commissions is a huge topic and one of the most important topics to study.
By understanding how different types of forex brokers make money through spreads and commissions, you also gain greater control over your earnings on the forex market. There’s just one last thing to keep in mind: since the forex market typically involves the leading currencies of the world, it can be greatly affected by economic turbulence. For example, both the 2008 financial crisis, as well as the coronavirus of 2020, had significant impacts on the forex market.
Ready to start forex trading? Check out our reviews of the top forex platforms.