What are spreads?
In forex trading, the spread is the difference between the bid and the ask price. It represents the service cost of the brokerage or the transaction fees involved in making the order. It is usually denoted in pips or price interest point, which means the fourth decimal place in currency quotation.
If brokers do not charge commission fees, they usually make money through charging spreads. There are 2 types of spread conditions offered by brokers – floating and fixed spreads. Looking into the type of spread is very important as just a slight change in the spread size can result to a significant difference especially during active trading.
From the root word fixed, this type of spread does not change regardless of the time or market condition. Although there are some cases wherein the spread charged is adjusted, it only happens during very low or very high liquidity. This change is usually temporary and the spread returns to its general level when the market returns to its normal condition.
The fixed spread may vary across currency pairs, but most major currency pairs range from 2 to 3 pips. It may seem a bit more costly compared to the other type of spread, but fixed spreads make it easier for traders to estimate transactions cost and hedge against market fluctuations.
Also called variable spreads, this type of spread is constantly changing depending on the current market condition. During normal or inactive trading times, this spread is usually very low, while it may widen a lot during high volatility market times. Floating spreads fluctuate because of supply, demand, and the total trading activity.
Under normal market conditions, floating spreads may vary between 1 to 4 pips. This may seem very low but it may multiply and widen during volatile market conditions. Floating spreads may have the advantage of lower size compared to fixed spreads, but it is nearly impossible to trade especially during news releases as it can widen too much, thus affecting the possible profits made through the transaction.
Which one is best for you?
Brokers usually offer both choices to their clients, but choosing which one to take depends on the kind of trading lifestyle you have. For medium to long term investors, floating spreads can be more cost effective because they tend to be lower during normal market conditions. For scalpers and active traders, fixed spreads could be more effective since they can easily trade during news releases without having to pay more and it ensures that the difference between the bid and ask levels wouldn’t change too drastically. Trading with fixed spreads can prove to be much easier and more predictable than floating spreads.
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