Cost of
Trading
Pip is very important for determining the cost of trading. In
currency trading, brokers offer to sell a currency at one price and buy it back at a lower
price. So, a broker expresses a currency pair in terms of the ask or buy price and the bid
or sell price. For example, if the ask price for the GBP/USD is 1.3421, it means that 1.3421
USD will be required to buy 1 GBP. If the bid price is 1.3417, it means that 1 unit of GBP
can be sold back to the broker for 1.3417 USD.
The quote price (bid/ask) for this currency pair is 1.3417/1.3421.
Note that the ask price is always higher than the bid price, to ensure that the broker is
able to cover their cost of doing business. This difference between the bid and the ask
price is called the spread, which is 4 pips in this case.
Spreads are influenced by several factors, such as the volatility in
the market, the level of uncertainty and the liquidity. Important announcements by the
central banks or economic data releases are the most common reasons for the widening of
spreads. Apart from scheduled events, factors such as political turmoil or other unscheduled
events can also widen the spread.
Spreads can be wider if the market is highly volatile or the volume
being traded is extremely low. In short, the spread, which is expressed in terms of pips, is
the minimum amount that the broker will earn on the purchase or sale of a currency or the
minimum amount a trader will pay on buying or selling a currency, if there is no change in
price. While looking to open an account, traders should look to open accounts with brokers
offering tight spreads. Some brokers offer spreads as low as 0.0 pips because of
their high liquidity levels.