Comparing the Spreads of Different Forex Brokers Can Be Complex
Comparing the Spreads of Different Forex Brokers in the forex spot market is surprisingly complex and often not well understood.
Yet nothing affects your trading profitability more. We will try to bring some light to the topic after covering the basics.
So before we start Comparing the Spreads of Different Forex Brokers you need to know what is a spread.
A Spread is the difference between the ask price (the price you buy at) and the bid price (the price you sell at) quoted in pips. If the quote between EUR/USD at a given moment is 1.2022 bid and 1.2024 ask, then the spread is 2 pips.
A spread is also how brokers make money. Wider spreads result in a higher ask price and a lower bid price. Thus, you pay more when you buy and get less when you sell, making it more difficult to realize a profit.
Brokers don't typically earn the full spread, especially when they hedge client positions. The spread compensates the market maker for taking on risk from the time it executes a client trade to when the broker's net exposure is hedged (possibly at a different price).
Comparing the Spreads of Different Forex Brokers is important, because Spreads can affect the return on your trading strategy in a big way. Probably more than you think. As a trader, your sole interest is buying low and selling high or vise verse (selling high buying low).
Wider spreads means buying higher and having to sell lower. A one-pip lower spread doesn't sound like much, but it can easily make the difference between a profitable trading strategy and an unprofitable one.
When Comparing the Spreads of Different Forex Brokers you must also take in consideration the Execution, and Depth, a Symbiotic Relationship. You see the tighter the spread, the better for you. But tight spreads are meaningful only when they are coupled with good execution.
The Quality of execution determines whether you actually receive tight spreads. Say your screen shows a tight spread, but your trade is filled a few pips to your disadvantage or is mysteriously rejected.
When this happens repeatedly, it means that your broker is displaying tight spreads but is effectively delivering wider spreads. Rejected trades, delayed execution, slippage, and stop-hunting are strategies some brokers use to void the promise of tight spreads.
No less important, spreads must always be considered in conjunction with depth of book. Unlike other trading markets, when it comes to economies of scale, forex doesn't behave like most others.
On the Interbank market, the larger the ticket size, the larger the spread tends to be. And in many cases, the tight spread offered applies only to capped trade sizes that are grossly inadequate for typical trading strategies.
You will find when comparing the Spreads of different Forex Brokers that some brokers offer fixed spreads that are guaranteed to remain the same regardless of market liquidity. (Caveat emptor: check the fine print for exceptions!)
But since fixed spreads are traditionally higher than average variable spreads, you are effectively paying an insurance premium throughout most of the trading day for protection from rare outbursts of short-term volatility.
Other brokers offer traders variable spreads depending on market liquidity. Spreads are tighter when there is good market liquidity but widen as liquidity dries up.
Which is a better choice fixed or variable spreads will depend on your trading pattern. If you trade only or primarily on news announcements--when markets tend to be volatile--you may well be better off with fixed spreads if the quality of execution is good.
Some brokers have different spreads for different clients: those with larger accounts or those who make larger trades may receive tighter spreads, while clients referred by an introducing broker might receive wider spreads in order to cover the costs of the referral.
Another comparing factor to look at is spread policies. Although a bit difficult to do because every broker is considerably different from one to another and the policies are often not very transparent.
As a result, many traders get caught up in promises, taking a broker's words at face value. The only real way to find out is to open an account with more than one and try them out.
The cost will be money well spent. Alternatively, see what their existing clients have to say, by asking for references, or consulting the broker's or market maker's (uncensored) bulletin board.
Finally, when comparing the Spreads of different Forex Brokers try various demo platforms. But beware: demo platforms often execute much better than the real ones.
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