"Spread" refers to the difference between the buying price and the selling price of a currency pair in foreign exchange transactions. The widening or narrowing of the spread directly affects the cost of investors in trading. This cost is not paid directly, but is inherent and potential. However, when the spread is wide, investors may not be able to buy or sell at the best or closest market price, whether entering or leaving the market, which is a disguised cost that affects the profit space.

Why is the spread not fixed?

 

In the international foreign exchange market, the spread of currency pairs is floating, so this potential cost can be large or small. The floating spread is affected by the market activity and trading volume, that is, liquidity. Generally speaking, the more people trade a currency/currency pair, the more counterparties there are in the market, whether buying or selling, who are willing to take and trade at close to the market price, and the narrower the spread will be. However, once the trading volume is insufficient, the number of transactions that can be matched will naturally decrease, which will eventually lead to a widening of the spread.

At present, most foreign exchange brokers only provide customers with an online platform and do not intervene in customers' transactions. Instead, they directly place customer orders on the foreign exchange market for matching. Therefore, investors naturally see the market price of the floating spread.

When are spread widening common?

The international foreign exchange market is established by the participation of individuals, enterprises, banks, various brokers, insurance companies, investment institutions, central banks and governments, and the market liquidity is extremely large. As mentioned above, the spread fluctuation is affected by market liquidity, so in the foreign exchange market, the spread change will remain within a certain range. However, the spread of each currency pair will still widen at certain times, which can mainly occur in three situations:

1. Economic data release

Especially the more important data such as local central banks' interest rate decisions, GDP data of various countries, and US non-farm data.

2. Light trading period

Some major countries are closed for holidays, and there is a period from the close of the U.S. market to the beginning of the Asian market.

3. Major emergencies

Some less predictable events include political changes and turmoil, terrorist attacks, disruptions to actual supply and demand, and black swan events.

The above situations can cause a sudden decrease in the liquidity of the foreign exchange market, because market participants will reduce transactions. Many times, before countries release important economic data and policies, uncertainty makes investors wait and see. When buying or selling orders suddenly disappear, the spread will also widen. If the result is beyond market expectations and there is a sudden rise or fall in the market, the spread may further widen.