Low Spreads are Important in Forex Trading
There are plenty of Forex brokers today all claiming to be the one to offer the tightest spreads in the industry. But be careful. What you read is not always what you get. To know which Forex broker really offers the smallest or the tightest spread, it is vital to understand first exactly what a spread is.
It is the spread that affects your trading profitability. A spread is rather complex. It is the difference between the ask price (that’s the price you buy at) and the bid price (that’s the price you sell at). Prices are always quoted in pips. For example, a quote between GBP/USD at a given point is 1.3222/4, then the spread is 2 pips, or if the quote is 1.32225/40, then the spread is 1.5 pips.
It is also important to take into consideration that on the interbank Forex market, the larger the size of the ticket, the larger the spread. A 1-pip spread on an ECN platform may be limited only to some trades. See more on Markets.com
A broker makes his money by using the spread. The wider the spread, the higher the ask price and the lower the bid price. A trader pays more when he buys and get less when he sells. A better profit opportunity is provided by a Forex broker that offers a smaller spread.
In order to make a profit, a trader will purchase currencies at a lower price and sell them at a higher price. A wider spread means a trader is buying high and having to sell low. A half-pip lower spread does not sound like very little, but it can be significant. Traders should try to calculate the spread and predict how much difference it will make as far as return.
Traders should also ensure that a Forex trader provides good executions. A timely execution will indicate whether or not a trader has actually received a tight spread. Forex brokers may promise to provide a small spread but if they don’t come through with the execution as expected, a trader may end up with a wider spread and pay more for the transaction.
Spread policies differ from one broker to the next. For this reason, all Forex policies must be transparent. Some brokers may offer fixed spreads despite the volatility in market liquidity. Since fixed spreads are almost always higher than variable spreads, a trader effectively pay more. There are Forex brokers who offer small spreads under specific market conditions and liquidities. As can be expected, spreads are tighter when the market liquidity is good but even tighter when the liquidity is less.
Choose a Broker
It is vital for any trader seeking to open a Forex account to understand the terms and conditions of the spread offered. He should make sure that there are no hidden costs. There are several broker online review sites which compare brokers and the features they offer. It is easy to see the spreads they deliver.
Since every trader has a different trading style, he/she should look for a broker that offers the option of a variable spread. With volatile markets, a fixed spread may be the way to go as long as the execution is good. Some Forex brokers offer both types of spreads so it is worthwhile for a trader to investigate which one best suits a trader’s interests.