Spreads and forex trading

Currency exchange is


often advertised as being


a commission-free market, with no exchange charges, regulatory


charges or data charges.

 However, currency


exchange providers do need to


earn money somewhere, and this is


generally done through ask/buy spreads.

 The


ask/buy spread is how a currency pair is quoted; the ask


price is the price at which traders can sell the pair, while the


buy price is the price at which traders can buy the pair. If


the EUR/USD pair was quoted at 1.4441 / 1.444, traders could sell


the pair at 1.4441 and buy it at 1.4444. This is a


range of 3 pips, or 3 units of 0.0001.

 There are 3


ways in which most currency exchange


providers earn money on spreads, through


offering fixed spreads, variable spreads or a commission based on a percentage of the spread.

 In the case of the


EUR / USD forex pair, if you were trading through a currency


exchange provider that offered a fixed


spread, the quoted spread would always be 3 pips, regardless


of market liquidity.

 Currency


exchange providers that offer variable spreads


could have spreads as little as one pip, or as big


as 5. These spreads are typically


based on the liquidity of a currency pair; if


the pair is awfully liquid, the spread is


generally narrower, and if the pair is not, the spread


is generally broader. The most


commonly traded currency pairs , for example


the USD/JPY, USD/CHF, GBP/USD, AUD/USD and EUR / USD, are more liquid and have lower spreads.


By contrast, exotic currency pairs , for example the USD/ZAR, are traded less


frequently so are less liquid and sometimes have


higher spreads.







Variable spreads could also alter


at different times of the trading day or different times of


the week when the volume of fx trades is higher or lower.







Other currency


exchange providers may charge a small commission


, for example two-tenths of a pip (or 0.00002), and then pass


your order onto an enormous market maker with whom it has a relationship. Such an arrangement could end in you receiving tight spreads that only


huge traders could receive otherwise.

So which is best?

Fixed spreads may protect traders from slippage,


which is when your trade is executed at a different price to the one you were


offered, due to underlying market liquidity. You may also


always know what price you may pay for a currency pair.


But in the long run this


frequently works out to be costlier


than variable spreads.

 In the case of forex providers that charge


commissions, it is worth finding out what else


the provider is offering. If you are charged a 0.00002 commission on


your trade, but are offered a software platform that is better than most online providers, it could be worth paying the additional cost.

 Variable spreads are


attractive because they should mirror the underlying


market ; however, the


effectiveness of this depends on


how well providers can make the market.

 As currency


exchange is an OTC market, banks, the first market makers, have


relations with other banks and online currency


exchange providers, and these


relations are based mostly on the capitalisation and


credit standing of each


establishment. Foreign exchange providers that


offer variable spreads will be able to pass on more


competitive spreads to its clients if they are


well-capitalised and have a good relationship with a


bunch of credible banks.     









Remember that CFDs and forex trading are leveraged products and can result in losses that exceed your 1st deposit. CFD trading may not be appropriate for everybody, so please ensure that you fully understand the risks concerned.