ANY BEGINNER TRADER’S MAIN CURIOSITY IS “WHAT IS A SPREAD ON FOREX”? SO, LET’S FIND OUT
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Let’s go :) What is a forex spread?
Any action costs a thing. It’s the way financial markets work. When we make a regular bank transfer, we pay the bank a fee for conducting the operation. If we pay services through payment kiosks, we are charged a commission as well. The forex world operates in the same way. We are customers and the stock exchange provides us with services.
We are interested in buying and selling financial instruments and we can get these instruments or, to be more exact, the prices for these instruments in a bank. We shall pay a commission for each action to the one who commits the action for us. The thing is, when conducting a trade on a stock exchange, you aren’t conducting it yourself. You are only sending your broker an order to conduct it.
The trade itself is executed by the broker that charges you a part of the trade. As I’ve already said, there exist several types of service on a stock exchange and therefore there are several commission types.
We are going to discuss the most popular commission type - a fee for making trades. If we wish to buy a currency pair, we will pay a partial cost of this currency pair expressed through a spread. The cost of an instrument or a currency pair is called “quote”.
This commission will be deducted from the quote and it’s what is called the “spread”. In other words, this commission is the difference between the quotes.
When we exchange currencies in a bank or using an exchanger, we see 2 quotes. There’s the buying price, at which the bank buys your currency, and there’s the selling price, at which the bank sells your currency. If we compare these 2 prices, we’ll see that the former is always lower than the latter.
This is what is called the “spread”, or the difference between the buying price and the selling price. The value of this commission is regulated by the financial organization that provides exchange services.
- Fixed spread. The spread whose value doesn’t depend on market factors and always remains the same. It’s normally determined by a broker or, to be more exact, a dealer. This type of spread was very popular at the beginning of Forex development but it’s rarely provided nowadays.
In most cases, a fixed spread is a favorable factor for a trader, but its value is usually higher than a raw market spread. You wouldn’t like working with such spreads. However, this type of spread remains popular with the champions of trading robots and scalping strategies because the algorithms of trading robots don’t need to be adjusted to it - Floating spread. The most popular type of spreading these days. It’s popular because it brings profits for both sides. Brokers and dealers can regulate and adjust it fast to changing market conditions, which allows solving 2 problems at a time: provide clients with higher-quality services and earn at the moments when the spread increases.
This spread fluctuates in a certain range based on changing market conditions. As a rule, floating spreads don’t exceed 4-5 points in the most liquid trading tools under normal market conditions, but they may enlarge sharply, reaching 50-60 points, during a sharp increase in volatility. That’s why floating spreads aren’t popular with traders who use robots and advisers because automatic strategies cannot consider changes in the value of spreads fast. This type of spread is favorable to manual trading.
WHAT SPREADS DEPEND ON
As I’ve already mentioned, the spread is a commission. If so, it needs to consider the interests of all participants in an exchange operation - a trade. As a rule, the spread forms as the stock exchange’s interest combined with the broker’s interest. The formula looks like the following
Spread = stock exchange’s (bank’s) spread + broker’s spread
The bank provides you with access to exchange operations and charges you a fee. As for the broker, it is an intermediary in exchange operations that passes your order to the stock exchange and therefore charges a commission for its participation in the process too. As the broker’s participation is more considerable, the broker’s spread size is larger than the stock exchange’s one.
Because the stock exchange is a coalition of banks in its essence, we may say that the stock exchange’s spread is charged by the bank that provides quotes to your broker.
The spread charged by the stock exchange is called “raw”, i.e. it’s a spread without mark-ups or broker spread added to it. There’s currently an opportunity to trade on the stock exchange with raw spreads. It became possible after ECN trading accounts were created. ECN - Electronic Communication Network
It’s a dedicated communication network for executing trading operations that doesn’t include an intermediary broker’s interest. It provides raw spreads.
This is what is called “zero spread Forex”. Actually, trading with no spreads is practically impossible, but this type of account provides for much tighter spreads. As long as the access to such trades is delivered by a broker, its interest is considered as well.
But this interest isn’t paid as a part of the spread now; it’s implemented in the form of the broker’s commission. In this case, the commission will be fixed and will only depend on the volume of the trader’s operation. Also, there’s another type of relationship
These accounts appeared much earlier than ECN. Their feature is that they include both the stock exchange’s and the broker’s spread and the spread will therefore be larger than a raw spread.
However, these accounts don’t have mark-ups, so they are more advantageous than accounts with fixed spreads. Also, these accounts don’t charge a commis