WHAT IS FOREX?
When trading forex, you need access to the market. This access is granted by the broker, the middleman which provides the retail trader with the opportuni- ty to execute trades electronically over a wide range of currency pairs. The broker however, does indeed earn money from each trader who utilises their services most often in the form of commissions.
In Forex trading there are two prices on a currency pair given at any time these are known as the ASK price and the BID price. The spread is the difference between these two prices and serves as the commission mark up for the broker (in PIPs). For example, when buying/ going long on a currency pair, your trade entry would be executed at the ASK price and when selling/going short on a currency pair your trade entry would be executed at the BID price.
As displayed above, the EUR/ USD (left) quotes display 1.3727(1) - 1.3729 (0) giving a spread value of 1.9 PIPs. This means that when you execute a trade, you automatically go into 1.9 PIPs negative so if the trade is a win or a loss, the broker gets paid their commission mark up regardless. In order to break even on a trade, a position must move in your direction by an amount equal to the spread.
The most liquid and most popular currency pairs tend to have the lowest spreads and are therefore much cheaper to trade. There are also cross currency pairs which have less liquidity and much larger spreads, dependent on your broker up to around 8 PIPs+ ! Meaning they are very expensive to trade. The spread figures are in constant fluctuation and can widen as volatility picks up, especially around fundamental/economic data releases. Instead of charging commission, banks and brokers earn from the spread of every trade entered and exited.
A cross rate is the exchange rate between two currencies which are not official to the country in which the exchange quote is given in. For example, if an exchange rate between the Australian dollar and the Japanese yen was quoted in a British newspaper it would be considered a cross rate and if the currencies quoted did include the British pound then it would no longer be considered so.