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Forex trading spreads, pips and fees explained
Read our simple guide to forex trading costs and technical jargon.
The world of forex trading can seem confusing and sometimes downright intimidating to newcomers.
If you're new to trading, you'll have to learn both forex jargon and technical trading.
To help get you started, let's take a closer look at what these technical terms mean and how they affect the cost of trading.
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades. Read the Product Disclosure Statement (PDS) and Target Market Determination (TMD) for the product on the provider's website.
How much does forex trading cost?
Unlike share trading, where the fee an online broker charges for each trade is clearly set out in black and white, the main cost you need to be aware of when trading forex is something known as the spread.
Rather than paying a flat commission or fee on your trade, the spread is the primary cost that applies to most forex pairs.
And here's where things start to get a little more complicated.
What's the spread?
No matter what currency pair you're trading, your broker will list two prices – the bid price and the ask price. The bid price shows the value at which you can sell the base currency of the pair, while the ask price is the price at which you can buy it from the broker. (Remember, the base currency is the one listed first.)
The difference between these two prices is known as the spread, and the ask (buy) price is always higher than the bid (sell price).
Taking the AUD/USD currency pair as an example, you might see your broker listing a sell price of 0.76594 and a buy price of 0.76604. Subtract the sell price from the buy price and you get a spread of 0.0001.
But the deeper you dive, the murkier things become for novice traders. This is because brokers commonly quote the size of the spread in something known as "pips".
Finder survey: What features matter most to Australians when choosing a forex trading platform?
| Response | |
|---|---|
| Low commissions | 68.18% |
| Tight spreads | 30.3% |
| Easy to use platform | 27.27% |
| Good range of forex pairs | 27.27% |
| Quality trading tools | 24.24% |
| Security and regulation | 22.73% |
| Speed of execution | 18.18% |
| High liquidity | 15.15% |
| Available platform (e.g. MT4) | 9.09% |
| Technical analysis tools | 7.58% |
| Availability of less common pairs (e.g. exotics) | 4.55% |
| Personal advice services | 4.55% |
| None of the above | 3.03% |
Source: Finder survey by Pure Profile of 1145 Australians, December 2023
What are pips?
As you've probably guessed, the term pips in this context doesn't refer to the seeds in an apple or watermelon. Instead, pip actually stands for "percentage in point" or "price interest point".
With this in mind, a pip is a standard unit of measurement that defines the smallest possible price change between a pair of currencies.
For example, a broker might announce that they offer minimum spreads on the AUD/USD currency pair from 0.6 pips. Some brokers will also use points instead of pips when outlining the spread.
Now, let's take another look at our AUD/USD example:
- A sell price of 0.76594
- A buy price of 0.76604
- Resulting in a spread of 0.0001
Most brokers quote currency pairs out to 4 or 5 decimal places. And for most major currency pairs, a pip is equal to a price movement of 0.0001 – in other words, check the 4th decimal place of the currency pair for price changes. So in our example above, the spread is 1 pip.
However, it's worth noting that the bid and ask prices for Japanese yen currency pairs are only quoted to 2 decimal places. As a result, a pip is equal to 0.01 for JPY pairs.
What does the spread mean for me?
Have you ever seen "no-commission" forex trading advertised and wondered how the broker makes any money? While a broker may not charge any commission on trades, that doesn't mean they offer their services for free.
Instead, rather than charging you a separate flat fee, the spread essentially allows the broker to incorporate their commission as part of your transaction. That's how brokers make a profit – they sell currency at a higher price than the price they buy at.
Of course, there are also other factors that can affect the size of the spread, including the volatility and liquidity of the currency pair you're trading. That's why major currency pairs have tighter spreads than emerging market pairs.
Calculating the cost of a pip
Now it's time to think about how the price movement in a currency pair affects your potential profit or loss. To do that, you need to calculate the value of a pip, which depends on the pair you're trading, the exchange rate and the size of your trade.
If you're trading a major currency pair where 1 pip = 0.0001, the formula is simple. Pip value = (trade amount x 0.0001) / the current spot price of the forex pair.
Let's say you place a $10,000 long trade on AUD/USD at 0.7651. The value of AUD/USD then increases to 0.7681 – an increase of 0.00300, or 30 pips.
The value of a pip is (100,000 x 0.0001) / 0.7681. So 1 pip is $13.02, and the profit on the trade would be 30 x $13.02, or $390.60.
What is a lot in forex?
When you calculate forex, you'll be working with lots.
Forex is commonly traded in specific amounts. These mounts are known as lots or the number of currency units you will buy or sell.
Basically, a lot is a unit of measuring a transaction and will be how orders will be quoted by your broker.
A standard lot is the equivalent of 100,000 units of the base currency. But there are also mini, micro and nano lots that are 10,000, 1,000 and 100 units respectively.
But remember, lots trade based on standard sizes.
- 100,000 units = 1.00 lot
- 10,000 units = 0.10 lot
- 1,000 units = 0.01 lot
Let's put this into perspective.
Say you have 100,000 units of AUD/USD.
And let's say the Australian dollar against the US is currently trading for $1.20.
If you were to receive 100,000 units of Australian dollars, in return you would have to pay $120,000 US dollars.
What other costs do I need to be aware of?
While many brokers make money from the spread rather than a commission, some also charge a separate flat commission on all trades.
This means they may offer tighter spreads than you can find elsewhere, but you'll need to consider the total cost of trading before deciding if this approach will be more cost-effective for you.
If you're a casual trader, you might be best suited to a zero-commission account, depending on the broker. In this case, you'll want to look for the lowest spreads on no-brokerage-fee accounts.
One other common fee to keep an eye out for is an inactivity fee. This fee is often charged on a monthly basis once you haven't made any trades from your account for a set time, such as 12 months.
Other trading charges may also apply. For example, you may be charged interest if you want to keep a position open overnight, the broker may charge a fee when you want to withdraw funds from your account or a currency conversion fee could apply if you trade in a currency other than your account's base currency. With this in mind, be sure to read the terms and conditions of your trading account closely.
If you're new to forex, there's a steep learning curve in front of you. But once you understand the jargon, and if you're willing to research the ins and outs of how the market works, you'll be in a much-better position to start trading.
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Disclaimer: General information only. All forms of investments (and in particular, trading CFDs, commodities and forex) carry significant risk, including the risk of losing more than the invested amounts, market volatility and liquidity risks. Past performance is no guarantee of future results. Such activities are not suitable for most investors.
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Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
Disclaimer: General information only. All forms of investments (and in particular, trading CFDs, commodities and forex) carry significant risk, including the risk of losing more than the invested amounts, market volatility and liquidity risks. Past performance is no guarantee of future results. Such activities are not suitable for most investors.
1 - 5 of 5
Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
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Important: The standard brokerage fee displayed is the trade cost for new customers to purchase $1,000 of either Australian or US shares. Where a platform charges different fees for both US and Australian shares we show the lower of the two. Where both CHESS sponsored and custodian shares are offered, we display the cheapest option.
Important information: Powered by Finder.com.au. This information is general in nature and is no substitute for professional advice. It does not take into account your personal situation. This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for most investors. You do not own or have any interest in the underlying asset. Capital is at risk, including the risk of losing more than the amount originally put in, market volatility and liquidity risks. Past performance is no guarantee of future results. Tax on profits may apply. Consider the Product Disclosure Statement and Target Market Determination for the product on the provider's website. Consider your own circumstances, including whether you can afford to take the high risk of losing your money and possess the relevant experience and knowledge. We recommend that you obtain independent advice from a suitably licensed financial advisor before making any trades.
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