Understanding Foreign Exchange Trading Spreads
By Ultimate Trading
You Must Find A Broker Who Offers You The Best Foreign Exchange Trading Spreads
Nothing affects your profitability more than the
exchange trading spreads offered by your Broker. But spreads in
the foreign exchange trading spot market can be confusing to
understand, and the marketing from many brokerages can be deceiving.
Nearly every broker is claiming to have the tightest foreign
exchange trading spreads in the industry. But what does this mean,
and how can you tell if a brokerage is delivering what they promise.
In order to understand the foreign exchange trading spread, you need
to know what it is. A foreign exchange trading spread is the
difference between the ask price (the price you buy at) and the bid
price (the price you sell at) that is quoted in the pips. The pips
are the smallest unit of difference between the two currencies in
the quote. If the quote between EUR/USD at a given moment is
1.2222/4, then the foreign exchange trading spread equals 2 pips,
the difference between the 2 and the 4. If the quote is 1.22225/4,
then the foreign exchange trading spread is going to equal 1.5 pips.
The foreign exchange trading spread is how brokers make their money.
Wider foreign exchange trading spreads will result in a higher
asking price and a lower bid price. The end result of this is that
you will pay more when you buy and get less when you sell, making it
more difficult to realize a profit. Brokers generally dont earn the
full spread, especially when they hedge client positions. The spread
helps to compensate the brokerage for the risk it assumes from the
time it starts a client trade to when the broker's net exposure is
hedged (which could possibly be at a different price).
Foreign exchange trading spreads affect the return on your trading
strategy in a big way. As a trader, your sole interest is buying low
and selling high (like futures and commodities trading). Wider
foreign exchange trading spreads means buying higher and having to
sell lower. A half-pip lower spread doesn't necessarily sound like
much, but it can easily mean the difference between a profitable
trading strategy and one that isnt.
The tighter the foreign exchange trading spread is the better things
are going to be for you. But tight foreign exchange trading spreads
are only meaningful when they are paired up with good execution. A
good example of this is when your screen shows a tight foreign
exchange trading spread, but your trade is filled a few pips in the
wrong direction, or is mysteriously rejected.
When this occurs repeatedly, it means that your broker is showing
foreign exchange trading spreads but is effectively delivering
wider spreads. Rejected trades, delayed execution, slipping, and
stop hunting are foreign exchange trading strategies that some
brokers use to get rid of the promise of tight spreads.
Foreign exchange trading spreads should always be considered in
conjunction with depth of book. Oddly enough, when it comes to
economies of scale, FOREX doesn't even act like most other markets.
On the inter-bank market, for example; the larger the ticket size,
the larger the foreign exchange trading spread is. So when you see a
1-pip spread on an ECN platform, you have to wonder if that spread
is valid for a $2M, $5M or $10M trade, which it probably isnt. In
many cases, the tight spread that is offered applies only to a
capped trade sizes that dont work for most of the common foreign
exchange trading strategies.
Spread policies change a great deal from broker to broker, and the
foreign exchange trading policies are often difficult to understand.
This makes comparing brokers difficult. Some brokers actually offer
fixed foreign exchange trading spreads that are guaranteed to remain
the same regardless of market liquidity. But since fixed foreign
exchange trading spreads are traditionally higher than average
variable spreads, you can end up paying an insurance premium during
most of the trading day so that you can get protection from
Other brokers offer traders variable spreads depending on market
liquidity. Foreign exchange trading spreads are tighter when there
is good market liquidity but they will widen as liquidity dries up.
When it comes to choosing between fixed and variable rates, the
choice depends on your individual foreign exchange trading pattern.
If you trade primarily on news announcements that you hear, you may
be better off with fixed spreads. But only if the quality of
execution is good.
Some brokers have base the foreign exchange trading spreads they
offer their clients on the type of account the client has. For
example; those clients that have larger accounts or those who make
larger trades may receive tighter foreign exchange trading spreads,
while the clients that are referred by an introducing broker might
receive wider spreads in order to cover the costs of the referral.
Other brokers offer the same foreign exchange trading spreads to
It is often difficult to get information on a companys spread policy
or its order book depth. Because of this, many traders get caught
up in the promises they hear, often take a broker's words at face
value. This can be dangerous. The only real way to find out what a
companys policy really is to try out various foreign
exchange trading brokers or talk to those who have.
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