Forex Trading: Forex Spread

Forex Trading: Forex Spread

So you have started on Forex Trading. As you trade, you notice that the price level you are entering changes dependent on the type of trade you are entering. If you are entering a sell/short trade, the price to enter is lower from the market average. If you are entering a buy/long trade, the price to enter is higher than the market average. Why is that so?

In Forex Trading, there is a concept called Spread. Spread refers to the price difference between the buying and selling price of a currency pair. This concept is ever present while changing money even at the money changers; most money exchanges have a differing buying and selling price. This difference in money price acts as the primary source of income for brokers and money changers alike; they are in the business to make money after all. But why are some spreads larger than others? What are some reasons why there is a huge difference of spreads? In this blog post, we will cover the various reasons why some spreads are larger than others.

One of the factors affecting spread is liquidity. The more liquid the currency pair, the tighter the spreads are. This is because more people are trading that currency pair, and thus there are readily available buyers or sellers willing to match your orders at a faster rate. As you observe more exotic pairs, you will also realize that the spreads are larger there, an indicator that there is not really a readily available buyer or seller to match your order, especially if yours is a large order.

Another factor affecting spread is volatility. As markets become more volatile, the spreads are adjusted to be larger so that brokers safeguard themselves from great market fluctuation, causing losses on their end. At the same time, it is trickier for to find a buyer or seller that is willing to buy or sell at the price that you are offering, causing the spread to widen significantly. This isn’t manipulation, but a circumstance created from market conditions. This volatility is heavily scrutinized and under regulation, and should a broker artificially widen the spreads beyond what market conditions justify, it could potentially be a violation.

The third factor affecting spread is the broker’s cut. While brokers do facilitate forex trades, they are not charitable souls doing it for nothing. Some brokers offer a fixed spread while others offer variable spreads that adjust with market conditions. Always compare brokers with one another to ascertain if the spreads you are experiencing are abnormally large; it could be that the broker is taking a bigger bite than the average broker.

One more factor affecting spread would be the time of the day that you are trading. During peak trading hours, more people are trading, increasing liquidity of the currency and thus tightening spreads. However, if you are trading at a quieter segment of the day, you may encounter wider spreads as the markets are not liquid enough at those timings. At the same time, take note for timings that are highly liquid and volatile; imagine a scenario where 80% of the traders are selling currency. There will be large spreads during that time as well possibly.

Last but not least, spreads can be artificially manipulated by brokers. There are brokerages out there that are not regulated, and thus do not follow any regulations about the amount of spread and the amount of fees they can levy on their clients. Be sure to do your due diligence and choose a broker that is highly regulated and known to be ethical. Compare for yourselves the various brokerages and identify which brokerage has the lowest spreads as well. Brokerage A might have a  lower spread for the EUR/USD pair, while Brokerage B has a lower spread for the USD/JPY pair.

The above are some reasons why the spreads are larger in certain circumstances. Traders are reminded once again to do their due diligence and trade cautiously. At the same time, be wary and compare the different brokerages to ensure that certain spreads are not artificially manipulated. Spread is an important concept to be aware of while trading so that you do not lose your money to the fine prints, and can trade with ease and comfortability knowing that there is no one out there manipulating the profitability of your trades.