Spreads are one of the fundamentals of Forex trading. Just like in other types of financial markets, spreads indicate the price difference between the buy and the sell price of the security. FX spreads not only impact the profitability of the trading strategy, but also determine the costs of trading.
In fact, every trader that deals with the online Forex broker must pay the spread. Whenever the trader enters the market, the broker will charge the cost of the spread. On top of that, the FX broker can also require the client to pay the extra fees for the order execution, though it is a completely different story. Currency trading market is very liquid with more than $4 trillion of daily trading volume. The liquidity of the particular currency pair correlates with its spread. To give an example, the high liquid pair is EUR/USD and it is most vigorously traded in the Forex market. Partially this is because the spread for this pair is considered to be the lowest. On the contrary, FX minors or exotics would offer much higher spread to pay which corresponds to the low liquidity of these FX instruments.
The size of the spread is also crucial when adjusting the trading strategy. A vivid example is the scalping strategy. Scalpers hunt for a tiny number of pips in a short-term and they strongly depend on the market volatility. Keeping this in mind, the scalping strategy profitability can be seriously influenced by the spread size, as it can cut already little potential gains. For the scalper, the main condition of trading with top Forex broker is the ultra-low spread. This leads to the point that the best broker for scalpers is the ECN.
Fixed or Variable?
In the Forex market, there are two types of the spread, namely fixed and variable (also called floating).
As the name suggests, fixed spreads remain the same during different market conditions. The fixed spread makes the transaction costs more predictable, which provides more opportunities for implementing particular trading strategies. For example, traders are free to trade news events that create an immense volatility for a short-term period. Fixed spreads are usually higher than the variable ones, but they secure traders from incurring additional costs.
The variable spread means that the costs of entering the market might vary significantly. In fact, the broker which offers the variable spread is merely reflecting the best current market prices. In the times of the high liquidity, the floating spreads tend to be much tighter than the fixed ones. However, the high volatility is not advantageous for traders that use variable spreads. The spread under such conditions can widen, thus making FX trading quite expensive.
The Bottom Line
As you can see, spreads play a colossal role in the retail currency trading. The types of the spread correspond to the different kinds of FX traders. Likewise, traders should always consider the spread size as it is a crucial factor when developing the trading plan.