When you look at forex brokers you will find that they charge a spread instead of a commission. It is important that you understand how these spread affect currency trading. You should not only look at the effect that spread have on your currency trading profits. You need to consider why spreads vary and what is behind this. When you know about the reasoning behind the spreads you can better understand their impact on currency trading.
The Variable Spreads
Many forex brokers offer variable spreads. These spreads fluctuate with market conditions and FX rates. This type of spreads brings the price nearer to those offered on the interbank system. You should consider the pros and cons linked to this type of spread before you opt for it.
Since the prices offered in this instance are closing to the rates offered on the interbank system, it makes your trades more profitable. The spreads could be as little as one and a half to two pips on major currency pairs. Exotic currency pairs will retain the normal width in spreads. Trading with variable spreads gives traders an insight into the market environment. In cases of narrow spreads, the market is generally good to trade. If the spreads widen, the market is generally not good for trade or it may be declining.
Variable spreads affect entry prices. This means that it is possible for you to enter similar trades at varying spreads. You may be able to enter a trade on day one at two pips per spread, and the same trade on day two at five pips. There are some types of strategies that do not integrate well with variable spreads as your stop and limit levels are dependent upon the spreads and prices. If you fall into this category, you need to confirm that your broker works on a fixed spread basis.
The Cost of Business
A forex broker’s cost of business is directly linked to the spread that is offered to retail traders. In cases where their costs are low, their spreads will shrink as the broker will not have to add too much to enable a suitable profit. Forex brokers pay fees related to their trades. These fees have become less over time. The reason for this is that there are more traders trading in this financial market, hence the liquidity of the market has increased. This has prompted more forex brokers to enter the market and this increase has caused a ripple effect into the financial institutions that do business with the brokers. The level of competition in the market has caused the financial institutions to offer the brokers much better rates than they used to. This is usually passed on to the broker’s client, the trader.
Currency Trading in the Spread
It is possible for you to trade within a spread, but very few brokers allow traders to do this. This is an ideal method for short-term traders and scalpers. Most short-term traders are generally looking at placing a sell point about five pips from the point of entry. This is sometimes rejected by the broker as they want a wider sell point.