Examining Spreads on the Foreign Exchange Market

This article looks at what the different spreads available to a trader on the foreign exchange market.

Foreign Exchange Market Spreads

When entering the foreign exchange market you will be forced to learn different terminology and concepts.  In order to be effective you must understand what a forex broker is and the spreads these brokerages offer.  There are two primary spreads that forex brokers offer – the variable spread and the fixed or set spread.  It is vital that you consider the different benefits and disadvantages of each before choosing a forex broker with which to trade.

The foreign exchange market spread

Unlike the stock market, the forex market sees its brokers earning ‘commission’ for their services via a spread.  This spread is the variance between the buy and ask prices on a trade.  While this is the primary means a broker uses to make money, there are some brokerages that charge an additional commission.  These brokers are generally those that utilise the electronic communication network or ECN.  In order to determine which broker is best for you it is advised that you compare different spreads and identify which is most beneficial to your trading.

Benefits and drawbacks of the fixed spread

The fixed spread refers to the situation where a broker charges a trader a set amount on a trade.  This is not as common as the variable spread as traders, but many traders do feel that a fixed spread may be more beneficial due to their consistency in an unstable foreign exchange market.

The primary benefit of a fixed spread is the set amount.  By having a set figure you will always be aware of the exact spread charge.  This allows you to utilise any trading strategy available as the spreads will not change.  You will also be able to conduct analysis with more accuracy due to the spread consistency.

A drawback of this spread scheme is that you will not get the best spread available.  The fixed spread is generally wider than the variable, thus if you are using a strategy requiring tight spreads it may not be suitable for your needs.

Benefits and drawbacks of the variable spread

The variable spread is the more well-known and frequently used of the two types.  The variable spread is a changeable amount that alters according to the market conditions and number of online traders; the rule of thumb is that the higher the market liquidity, the tighter the spread.  Of course, this is not always the case as forex brokers do try and take advantage of these highly active conditions.

The major benefit of a variable spread is the beneficial price.  This type of spread is usually tighter than the fixed spread and is a direct reflection of the interbank market.  It also offers an insight into the forex market and its movements.

The primary drawback of the variable spread is its instability.  Unlike the fixed spread, when utilising this type of spread, you have no idea of the ultimate amount you will be paying.  This can be damaging for certain traders as specific trading strategies require tight spreads, and this cannot be guaranteed with a variable spread.

 

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