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In today’s forex market, many brokers will try to sell you on the idea of “tight spreads” from as low as 0.1 pips. They conveniently forget to tell you that the 0.1 pip spread you were promised doesn’t apply to most of your trades because of things like market liquidity and trading volumes. If you were one of the countless traders who were promised tight spreads but haven’t received them, keep reading.
The bid/ask spread (or spread for short) is one of the most basic, yet critical aspects of forex trading. In forex, a spread is the difference between the highest price that a trader is willing to pay for a currency pair and the lowest price for which a trader is prepared to sell it. In short, a spread can be thought of as the cost of trading a particular market.
Spreads can be influenced by a number of factors, including:
For these reasons, the spread is considered a key measure of overall market liquidity.
In forex trading, spreads are of two types: variable or fixed.
A variable or floating spread is a constantly changing value between the ask and bid prices2. In other words, the spread you pay for purchasing a currency pair fluctuates because of things like supply, demand and total trading activity. Brokers promising tight spreads typically offer variable spreads. Although it’s certainly possible that the actual spread you pay for matches the one advertised by the broker, this is not always the case. In general, spreads are usually tighter during active trading sessions where liquidity is optimal. A prime example of this is the London-New York overlap3. After all, variable spreads are characterized as a “completely market phenomenon.”4
Unlike variable spreads, fixed spreads are set by the broker and don’t change regardless of market conditions or volatility. The spread you are offered is the spread you pay.
Although variable spreads marketed at 0.1 pip look more appealing, fixed spreads can potentially save you more money throughout the course of your career. Below are five advantages of fixed spreads in forex.
In forex, fixed spreads mean transparent costs. You know exactly what you’re going to pay for each time you trade, regardless of interbank liquidity, time of day or trading volumes. This ensures that brokers can’t manipulate the spreads in their favour.
By applying fixed spreads, you can greatly reduce the cost of trading. Fixed spreads offer no surprises, ensuring you can budget the costs of transactions well in advance. This will greatly improve your ability to manage costs over the course of your trading career.
Trading the news is one of the most effective ways to make money in the forex market. Unfortunately, variable spread accounts can make news trading very confusing because of how wide the bid and ask fluctuate. By using a fixed spread, traders may approach news trading as they would any other market condition.
Volatility in the forex market has become commonplace, and isn’t limited to news events. While variable spreads may be beneficial during quieter market times, fixed spreads are ideal for volatile market conditions5, which just also happen to provide more opportunities to make money.
1. Investopedia. Definition of ‘Spread.’
2. IFC Markets. Floating and Fixed Spreads.
3. Forex CFD Trading: Fixed Spreads or Variable Spreads. Contracts-for-difference.com
4. IFC Markets. Floating and Fixed Spreads.
5. Capital Spreads. Fixed or variable FX spreads
6. Investopedia. Forex Scalping.
7. Fixed Spread in Forex Trading – Four Solid Reasons to Choose It. Traderji.com.