Spread

The term inter-bank prices are often discussed in FX terminology. As implied by the name this refers to the exchange of information or in this case live prices between banks and large institutions, these prices reflect the current rate at which their they or their clients are prepared to buy or sell a currency. Inter means between and Bank means deposit taking institutions (these are normally made up of banks, large institution, brokers or even governments).

Today with the introduction of the internet, the market has moved on to such a degree that Forex Place can offer inter-bank prices to their clients with far less restrictions and much greater flexibility then can be found at the banks.

However in order to guarantee stability of the live prices you see on the Forex Place trading platforms (Metatrader4 and 4XP Professional) we use a number of centralized feed sources to ensure the reliability of our quotes.

The quotes for Bid and Ask prices are all generated from reliable sources and ensure that they represent the true value of the market at that given second. The spread is the difference between the Bid and Ask prices, the greater the difference the greater the spread and the harder it is for the trader to make money on the trade. This can best be shown by an illustration.

Let’s talk about our business traveler once again, however this time in more realistic terms. We discussed a businessman that was looking to travel from New York to Frankfurt. He had $5,000 cash on him, and he wanted to transfer his US Dollars to the local currency unit Euro.

The inter-bank market was, as discussed earlier 1.3428 to 1.3431. He approached the local money changer and he was told that he could buy his Euro’s at a rate of 1.3800, having very little choice (since all the non-commission money changes were offering the same rate) he sold his 5,000 US Dollars and received (5000/1.3800=) 3,623.19 Euro’s. As it happened, there was at that same time a lady that had just arrived to NY from Paris and wished to purchase 5,000 US Dollars as spending money for her holiday vacation.

The same money changer told her that she could sell her Euro’s at the exchange rate of 1.3000 once again the lady purchased the US Dollars and sold her Euro’s since there was very little choice in the manner. She received her 5,000 US Dollars and paid (5,000/1.3000=) 3,846.15 Euro.

As can be seen the money changer made a profit of (3,846.15-3,623.19=) 222.96 Euros on the two transactions. The spread taken by the money changer in this case was 1.3000 to 1.3800 or 0.0800 which is known as either 8 figures (each figure is worth 100 pips or points) or 800 pips or points. On percentage terms the spread represents (0.08/1.3430*100=) 5.96% or for simplicity sake a 6% spread. This is a realistic example of the spread one would expect to receive from money changers around the world.

The question is why the businessman or the lady on holiday would agree to such a rate, the answer is there is not much of a choice. The inter-bank rate is available to just about everyone today however only when the trades are non-delivery, that means that actual funds are not actually exchanged.

In order to receive inter-bank rates for delivery or exchangeable funds like the businessman above, very large amounts normally have to be traded on a regular basis with a bank or other major financial institution.

On a spread of 6% it would be virtually impossible to profit out of the foreign exchange market (unless of course you were the money changer).

The spreads offered by brokers make that scenario entirely different; let’s examine the inter-bank spread in the examples given above:

Instrument Bid Ask
EUR/USD 1.3428 1.3431

Here we see that the spread being offered by the broker on EUR/USD is 0.0003 or 3 pips or points. At Forex Place our standard spread on EUR/USD is 3 pips fixed, which is a very aggressive rate.

In percentage terms we can see that a 3 pip spread on EUR/USD is equivalent to (0.0003/1.3430*100=) 0.0223%, that’s a significant difference between the money changer rate showed above, and this is what makes trading in Forex so attractive as the spreads offered by Forex Place are so small and with zero commissions added that making money in FX is a real possibility.

A Pip or a Point

A pip can best be described as the smallest increment in price of a currency pair being offered.

In the case of the EUR/USD above we can see that one pip or point is worth 0.0001, (or 1/10,000) the last decimal point of a quote. The pip is how we calculate our profit or loss on trades.

It should be noted that on most currency pairs 1 pip is equivalent to 0.0001 or the fourth number after the decimal point, however when trading JPY crosses 0.01 is a pip (1/100) the second number after the decimal point.
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Calculating the Value of a Pip or Point

In order to calculate the value of one pip the following needs to be done:

Major Currency Amount Traded*the Pip value=amount in the secondary currency.

Either divide (if the USD is the major currency), or multiply (if the USD is the secondary currency) this number by the USD exchange rate to receive the pip value in USD.

This can best be shown in an example:

Let’s use the rates given earlier:

Instrument Bid Ask
EUR/USD 1.3428 1.3431
USD/JPY 123.40 123.43
GBP/USD 1.9926 1.9930
USD/CHF 1.2375 1.2379
EUR/JPY 165.70 165.74
EUR/GBP 0.6737 0.6740
AUD/USD 0.8468 0.8472
USD/CAD 1.0655 1.0660
EUR/CHF 1.6620 1.6624
GBP/JPY 245.89 245.99

A pip in EUR/USD for an amount of 100,000 Euro’s is 100,000*0.0001= 10 US Dollars
A pip in USD/JPY for an amount of 100,000 US Dollar’s is 100,000*0.01/123.40= 8.10 US Dollars
A pip in GBP/USD for an amount of 100,000 Sterling is 100,000*0.0001= 10 US Dollars
A pip in USD/CHF for an amount of 100,000 US Dollar’s is 100,000*0.0001/1.2375= 8.08 US Dollars
A pip in EUR/JPY for an amount of 100,000 Euro’s is 100,000*0.01/123.40= 8.10 US Dollars
A pip in EUR/GBP for an amount of 100,000 Euro’s is 100,000*0.0001*1.9926= 19.93 US Dollars
A pip in AUD/USD for an amount of 100,000 Australian Dollar’s is 100,000*0.0001= 10 US Dollars
A pip in USD/CAD for an amount of 100,000 US Dollar’s is 100,000*0.0001/1.0655= 9.39 US Dollars
A pip in EUR/CHF for an amount of 100,000 Euro’s is 100,000*0.0001/1.2375= 8.08 US Dollars
A pip in GBP/JPY for an amount of 100,000 Sterling is 100,000*0.01/123.40= 8.10 US Dollars

As mentioned before, the profit or loss on a trade is always calculated in the secondary currency, but in most cases the broker will do all these calculations automatically and convert all profit and losses to the currency of the initial client deposit.

So although when trading it is not necessary to know how to work these values out, it is of course useful to know that you can.