The difference between the bid and the ask prices is known as the bid-ask spread. Bid-ask spreads are like part of our business cost in trading. Like transaction commissions, it is how the forex brokerages make money out of us. Certain forex brokerages offer fixed bid-ask spreads depending on the currency pair (eg, Interbank FX) and some forex brokerages offer variable bid-ask spreads that can be as low as 1/2 pip! (eg, MB Trading) WAIT! There is a catch! Seriously, if a brokerage is just charging 1/2 pip, we’d better not stick with the brokerage for too long
Typically, for brokerages with low bid-ask spreads, they charge commissions for each filled transaction. Then when should we use which brokerage?
To buy 1 lot of USD/JPY with Interbank FX, it will cost $3. Interbank offers 3 pip fixed spread for USD/JPY mini account and there is no transaction commission.
To buy 1 lot of USD/JPY with MB Trading, it will cost $6. MB Trading offers 1 pip spread for USD/JPY (can go to 0 pip spread at times!) and there is a transaction commission of $5.
On the other hand, let’s look at buying 10 lots of USD/JPY. This is cost $3 X 10 = $30 with InterbankFX and ($1X10) + $5 = $15 with MB Trading.
With the above example, it shows that it is more cost effective to use brokerages with fixed spreads when our trading lot size is small.
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It is also known as slippage. It is important to know and understand, not knowing it will eat into you cost of your trading. Slippage and commission can drain your trading profits especially when you over trade.