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Posted on Feb 26, 2020 at 11:31 AM
Before you go on to make that decision of choosing a broker, one of the key things to consider is SPREAD. Spread is what your broker gets on every trade you place and let's just say it's your rent for using the broker's platform. Today, we will breakdown what spread is, the type of spreads available worldwide and the correct approach to selecting your broker.
What is “SPREAD” in Forex?
In Forex, brokers normally quote two different prices for currency pairs: the bid (BUY) and ask (SELL) price. The difference between these two (Buy & Sell) prices is known as the “spread”.
Generally speaking, the spread is how “no commission” brokers make their money. Instead of charging separate fees for making trades, the cost is built into the buy and sell price of the forex pair you want to trade.
How is the Spread in Forex Measured?
The spread is usually measured in pips, which is “the smallest unit of price movement of a traded asset”.
For most currency pairs, one pip is equal to 0.0001. InstaForex has a fixed spread of 3-pips on all Forex Majors currency pairs, so an example of a 3-pip spread for EUR/USD would be
EUR/USD: 1.2332 /1.2335
However, currency pairs involving the Japanese yen are quoted to only 2 decimal places – an example of a USD/JPY quotes would be
USD/JPY: 109.51 /109.54
These examples quote indicate a 3-pip spread for a 4-digit price quote (where the number of figures behind the decimal is 4).
Note that a 5-digit price quote would carry an extra digit each. So for the same currency pair, they would look like this
(EUR/USD 1.23329 /1.23359), and (USD/JPY 109.517 /109.547)
For these 5-digit price quotes, the spread is still calculated as the 4-digit quotes, while the extra 5th digit is negligible (they are less than whole numbers and will only count as 1 cent at every point in time).
Generally, What Types of Spreads are available in the Forex Market?
The type of spreads seen on a forex platform is determined by the structure of business offered by the forex broker. However, overtime there are two types of spreads:
Fixed spreads are usually offered by brokers that operate a market maker model of business, while floating spreads are offered by brokers operating a non-dealing desk model of brokerage business.
What are Fixed Spreads in Forex?
Fixed spreads stay the same irrespective of what market conditions are at play at any given time.
In other words, conditions of slippage or intense volatility do not affect a fixed spread and this is a huge advantage for traders. Fixed spreads are seen with brokers that offer the market maker business model.
With this model, the broker buys off large positions from the liquidity providers and offers these positions in smaller chunks to traders using a dealing desk.
Thus, the market maker acts as the counterparty to the trade.
In this manner, the broker is able to offer fixed spreads to its clients because they are able to control what is offered to these traders using the dealing desk, making it very affordable for trading.
What are the Benefits of a Fixed Spread Broker?
Therefore, fixed spreads offer a viable and cheaper alternative.
If you are a scalper, then the fixed spread is best for you. Scalping involves taking very small profits in many trades within a day. Obviously, the spread will impact on any profits made, so scalpers will be better served using fixed spreads.
What are the Disadvantages of a fixed spread broker?
There will always be times when pricing moves very fast as a result of supply-demand dynamics. With no room for spread adjustment to accommodate these movements, the broker has no option but to ask the trader to accept a new entry price provided for the trade. This is very normal since you still pay the same fixed spread.
Finding The Best Fixed-Spread Broker For You
Overall, none of the traders would like to be overcharged by high commissions and spreads while trading, thus the basic principle is to make a profit and perform secure trading with initially small costs paid to the broker.
Recently with the trend on the No Dealing Desk and Straight Through Processing brokerage providers, most traders are allured by the lowest spread possible, or in other words the cost which trader initially pays to the broker.
Of course, it is super necessary to obtain fair trading conditions, yet you as a smart trader should consider all the pros and cons of the particular offering and opt for that which suits your trading strategy.
As an example, Low spread is crucial to perform Day-trading, Scalping and Hedging strategy, as it’s lowering the cost since these trading styles perform a lot of open and close positions during active trading session.
Yet, the traders that hold long term position may require fixed spread, as it eases calculations on costs, and as well deliver stability under any market conditions.
Therefore, as the first step, choose among regulated brokers that suit your current trading need, compare their spread offering and then select the one.
It is true that some of the very reputable and fair brokers may propose a little lower or little higher spread, yet always remember to compare the full offering in order to find the best deal.
Knowing this, Would you rather go for a spread that is stable regardless of market volatility or go for a floating spread which is provided based on market liquidity and widens at extreme volatiliy?
Let's hear your thoughts in the comment section below.