Trading in Forex: Spread and commissions
After having a clear idea of what the pips and the different lots are in Forex, another relevant aspect that one must know take into account before trading in the largest market in the world is the concept of the spread. It fundamentally impacts our profitability.
If you have ever explored the vast and widespread world of Forex brokers, you will know that fees are applied based on a particular commission plus a flexible spread based on several different factors.
What is the spread?
We have been talking about the quote of a currency pair, but in fact, in Forex every currency pair each has two instant quotes: one if we want to buy, and another if we want to sell. Alternatively, the price ask(supply) and the price bid (demand). I will always buy at asking price and sell at bid price.
As you can imagine, both quotes differ in a few pips, and it is precisely this difference that is known as spread. The asking price of purchase will always be higher than the asking price of sale. For example, imagine that the euro-dollar has an ask price of 1.1084 and a bid price of 1.1082. That assumes that the spread at that time is 2 pips.
The spread, also commonly known as a hairpin, is totally natural in the market, and is a variable figure over time, depending on the currency pair being traded.
As a rule, spreads are extended in times of high volatility in the market, such as when there is news, and you have to be very careful to trade in such circumstances as spreads can be triggered noticeably. It is important to know that the spreads also depend on the broker you’re dealing with, so the choice of Forex broker/trading platform is important.
If you take a look at the commissions charged by different brokers in Forex , you’ll note that the variety of proposals is almost endless. However, you should know that essentially there are two modalities of trading in Forex as far as commissions are concerned: fixed spreads and variable spreads.
In the case of the fixed spread, each currency pair has its spread pre-set for normal market conditions, and that is the spread that the broker will charge for each transaction. In the case of the variable spread, these spreads vary depending on the moment, and as you can imagine, they are quite cheaper than the fixed ones.
To give an example, let’s say OANDA offers a fixed spread for the euro-dollar of 2 pips, while its variable spread is 0.5 pips. Of course, in the case of trading with variable spread, on each side of the transaction (buy and sell) we would have to add a commission of about $3 per lot (depending on the broker of course).
So, what criteria should be followed to choose one option over the other? In general, for newbies, it may be a good idea to trade with fixed spread to know the actual purchase and sale price more clearly. But you should be aware that variable spreads, being noticeably lower, are often the preferred option for intraday trading strategies.
In any case, you must be able to understand the advantages and disadvantages of each methodology based on the way you do trading, and I strongly suggest you stay tuned for more education forex articles and read up on other forex articles as well before you dive into this potentially lucrative market.