In forex trading, one aspect that every trader must take into account when choosing a forex broker, is the degree to which the broker will apply the trading spreads. The spread can even affect the profit or loss one stands to earn or incur in a particular trade.Other factors such as what is the maximum leverage provided, the range of services offered and even the available currency pairs may be important but one has to also appreciate the importance of low spreads especially for turning profits in both the short and long run..
Choosing a broker with unrivaled low spreads can help minimize transaction costs, allowing traders to keep a greater portion of their profits. In this article, we will explore the importance of understanding low spreads when choosing a broker and give some valuable tips to assist you in making a wise choice.
Understanding the Basics of Forex Spreads
In the realm of Forex trading, the term ‘spread’ refers to the difference between the purchase price (the price a broker pays in order to buy a currency), and the selling price (the price a broker sells out a currency). This is how much profit every broker earns on every transaction. Since the trader’s primary concern is the cost of transacting, this will lead the trader to select brokers with tighter spreads as this would be cheaper in opening or closing any position.
As an example, consider that we are trading the EUR/USD currency pair with an associated spread of 1.2 pips. Accordingly, it does indicate that, if one was to open the position and then incur the cost of the spread, that person would have to wait until the price moved in his/her favor by 1.2 pips, in order to break even from the trade.In the scenario described above, however, a narrower spread of 0.5 pips would only require a smaller amount after reaching breakeven before the profit can start being realized.
How Forex Spreads Impact Your Profitability
The profitability of forex trading is dependent, among other things, on the low trading spreads. Every trade that you make has a cost associated with it i.e. the spread. For example, those who employ high-frequency trading or any other short-term oriented strategies will be sensitive even to a part of a pip. Therefore, we can look into the example of two traders who have different brokers and face different spreads:
| Broker | Spread on EUR/USD (pips) | Average Daily Trades | Monthly Trading Volume (lots) | Monthly Cost from Spreads |
| Broker A | 1.5 | 10 | 30 | $450 |
| Broker B | 0.8 | 10 | 30 | $240 |
In the case e.g. Trader him/her if using Broker A whose spread is 1.5 pips and monthly expenditure is 450 dollars. Trader B on the other hand has spent only 240 dollars altogether, lower spread entailed a lot of costs especially for long periods of time which can lower a trader’s profit margin significantly.
Transaction Costs Beyond Commissions
Almost every trader has heard of the term commissions and knows what it means, however what most traders do not realize is the fact that spread is an additional cost which comes with every trade made.
For forex brokerage houses, spread forms a more stable and continuous expenditure rather than commissions’ pay out. A good number of brokers provide accounts that do not charge any commissions but increase their spreads as a way of covering the cost. To illustrate, an ECN broker may apply a low commission charge but provide extremely narrow spreads while market makers can provide commission free accounts but with collaborating encouragingly higher spreads.
Low Spreads and Their Role in Better Entry and Exit Points
Regardless of where investors are situated with respect to a particular market center or how much capital is at stake, slippage is of less encumbrance to all except day traders or scalpers as their approach to trading differs. As a result, currency pairs such as EUR/USD or GBP/USD, etc. have better rates as compared to other currencies because these are highly liquid allowing a trader to buy and sell within little or no slippage incurred.
Take for example slippage which is experienced in the execution of the order where the order is placed and the level quoted within the market is wide. The price filled when the order is completed is not the price anticipated since the market price has dislocated due to volatility or due to the time taken by the broker to execute the order. Such slippage can limit the profit that would be realized from the completion of a losing position or exacerbate the cost of closing a winning position; hence it is advisable to engage with low spread brokers, more so in a fast moving market where high profits are targeted.
Factors That Affect Spread Size
The magnitude of a forex spread can be affected by various factors. Familiarizing oneself with these factors will assist you in choosing the broker who is most compatible with your trading style and goals.
Liquidity of Currency Pairs
Most usually traded instruments in terms of trading spreads are liquid currency pairs, preferred majors such as EUR/USD or USD/JPY. These pairs are associated with high volume trading which lowers the cost for brokers in executing trade orders. On the other hand, exotic currency pairs for instance USD/TRY might have higher transaction costs as a result of an illiquid market.
Market Conditions
Wider bid-ask spreads are often witnessed during high volatile periods where the economic indicators are being released or where there are political frictions. Since some brokers offer fixed spreads regardless of market conditions, it can be said that their competition does not provide such offering of fixed spreads. There are brokers who offer floating spreads, which change in accordance with the liquidity of the market or the volatility of the market.
Broker Type
Different types of brokers handle spreads in different ways:
- Market Makers: They may widen spreads during periods of low liquidity or market stress, as they set their own prices.
- ECN Brokers: These brokers typically offer tighter spreads because they connect traders directly to liquidity providers, but they may charge a commission.
Account Type
There are some banks which offer bifurcated accounts meaning the account holder has certain limits within which he can make his spreads. As such, certain account types known as VIP or ECN seemingly have lower spreads although a bigger minimum deposit is prerequisite. Most of margin account users should know that if the brokers can increase the leverage they offer which helps to increase profits, they can also widen the spread in the equity margin accounts.
Regulatory Compliance and Its Effect on Spreads
Supervision is one of the legal frameworks that helps in bringing the operational norms of a broker – including the pricing of spreads – within acceptable limits. Poorly imaginative or poorly thought-through concepts and ideas are usually poorly regulated. For example, such regulation typically involves the imposition of restrictions on brokers by various bodies whose primary purpose is to monitor their activities – Financial Conduct Authority (FCA), Australian Securities & Investments Commissions (ASIC) or Cyprus Securities and Exchange Commission (CySEC) – in a manner that helps keep spreads tight. A nefarious strategy known as ‘slippage‘ is often employed by non-regulated brokers as an operational tactic within the spread for the benefit of the broker but to the detriment of the trader.
A reputable forex broker operating under regulatory guidelines is less likely to engage in unfair practices like increasing spreads during normal market conditions or executing trades at unfavorable prices.
How to Research Brokers for the Best Spreads
Finding a broker with low spreads might require you to carry out a lot of homework. Here are some useful hints on how to identify the best forex broking services for your needs:
Review Comparison Websites
Seek out evaluation portals that assess Forex brokers according to the amount of their spread. They usually give helpful information about brokers and their performance during various trades, especially those with the tightest spreads.
Read Reviews and Feedback
User testimonials can provide you with an understanding of how the spread of a broker holds up under actual working conditions. Pay attention to the comments that deal with trading placed on news events or other times of market instability since such times usually reveal the flaws of brokers on their spreads.
Try Demo Accounts
A lot of brokers provide demo accounts which let you experiment with their trading capabilities and spread limitations without putting any actual money at risk. This is a very good means of evaluating just how tight the spreads of any broker are over time. Thank you for the text content that is applicable to the general public and is in accordance with the stipulated guidelines.
Contact Broker Support
In case you have doubts about a brokerage’s spread structure, please contact their support team to ask for clarification. Any trusted brokerage should be able to advise clearly as to the spread that they are offering, whether it is a fixed or a variable spread, and how much the spreads are likely to change in certain market conditions.
Making the Final Decision: How to Choose a Broker with Low Spreads
When it comes to choosing a broker that has the least trading spreads, understanding their market rates is not quite enough. One has to look at the wider picture and this includes the speed of the trading platform, the quality of support service and even the stability of their spreads in different market situations.
- Assess the Spreads in Comparison with the Previous One in Different Market Situations: Assess the behavior of a broker’s spreads in quiet and busy market periods.
- Look at the Regulatory Standing of the Broker: Work with a licensed broker adhering to the European Standard Operating Procedures to prevent cases of irregularities in pricing.
- Practice Using a Demo Account: This will provide you with the actual picture of how tight the spreads in the market are.
- Account for Non-obvious Expenses: Watch out for hidden charges which may diminish the benefits obtained from low spreads.
Conclusion
In situations involving the wagering of bets in forex trading, the most paramount factor that is instrumental in making profits at minimum costs is the identification of a broker whose spreads are relatively low. In addition, this indicates that you are also aware of how spreads work and appreciate the incomes they are expected to generate. These come in handy tips for you when you meet with a broker.
It is also important that you do not forget to study carefully, open practice accounts and take into account all the benefits provided by the brokerage, not only the offered spread values. Comprehensive knowledge of spreads, in addition to picking the right broker who has good regulation and great support, will help you avoid incurring unnecessary expenses and instead contribute to your success in the forex business.
