When looking for a prospective broker a prospective trader/investor should research how the forex broker price their spreads. Most often it’s not easy to miss as it’s advertised quite visibly. There are basically two kinds of spreads.
- Fixed Spreads
- Variable Spreads
In order to understand these two, we need to first know what spreads mean in forex trading terminology.
Why should I be bothered by spreads.
Over a period of time, the spreads that a trader pays to the forex broker while executing the trades ends up costing a significant amount, and should be a key consideration when choosing a Forex broker. Every forex trader pays a spread. A spread is the difference between the ask and bid price. It is the spread that earns market markers, or in other words the forex broker you trade with, their profit.
With variable spreads, the difference between the buy and sell price of a particular currency pair fluctuates in a range. A variable spread for the EUR/USD pair generally differs between 1 to 4 pips for most brokers, but during volatile market conditions can actually widen to as much as 8 or even 10 pips. A variable spread widens in correlation with increased liquidity in the market and is really only low during times of market inactivity.
Variable spreads may often set off protective stops and limits unwittingly, if your forex broker offers the option to put a stop limit on your trades. If the difference between the Bid and Ask widens and reaches the level of a stop or limit, this large gap may suddenly execute a conditional order. This adds an extra variable to your strategy that you need to consider. This might be less likely to occur with fixed spreads because the Bid and Ask are always synchronized. Fixed spreads minimize the element of surprise; traders know exactly what the parameters are at all times, allowing for better strategic planning and money management.
Fixed spreads are predetermined and remain constant throughout all trading conditions. In other words, they do not fluctuate. A fixed spread will usually fall within the range of a variable spread, and is commonly set at either 2 or 3 pips for EUR/USD for example. Though traders essentially pay a small premium during quiet market hours, when a variable spread may be lower, the broker ensures that the spread will not widen during even the most volatile market conditions. Fixed spreads allow traders to better strategize without factoring in an unpredictable variable that inflates transaction costs during times most critical to traders.
From the above two explanations it is quite evident that the period of time you trade influences your decision to choose a broker that either offers fixed or variable spreads.
If you are a trader who executes trades during volatile market hours, then perhaps a fixed spread is what you should look at. On the other hand, variable spreads may be more suited to long-term traders who do not trade during news events and are prone to entering and exiting during quiet market conditions.
To illustrate with an example:
If a trader were to enter the market during off-peak times with a variable spread of 1 or 1.5 pips on EUR/USD as opposed to the fixed 2 or 3 pip spread on many platforms, the trader would save money on the spread in the long run.
100 trades at a fixed spread of 2 pips = $200 in spreads
100 trades at variable spread of average 4.6 pips = $460 in spreads
The best spread structure for you depends on your trading style, appetite for risk, ability to react in a fast-moving market, and ultimately, the quality of execution. Fixed spreads are consistent and predictable regardless of market liquidity. On the other hand, variable spreads tend to provide lower costs only during quiet market conditions