How Spread Can Affect Your Forex Trading
Spread is present in Forex Trading just like it is in the business world.
When business owners sell a product to someone, they don’t do it at cost. They add a markup/margin AKA Spread so that they can make a profit off of the transaction.
This cost is what allows most brokers to make a profit and stay in business. If not spread, then it’s commission. But how does spread affect your trading?
Your Trading Entries
In Forex Trading, You will rarely get into a trade at the exact price you wanted to get in at unless you’re a bank or you’re into dark pools or whatever.
For most retail traders, this won’t be the case. Not getting in at the exact price you want is not a train smash if you’re a position trader or a swing trader, but as a day trader and as a scalper, you definitely need something close to the price you wanted to make a strategy work.
Spread messes up your RR (Risk Reward ratio). Instead of a trade being a 1:5 trade, all of a sudden, it becomes a 1:3 trade because your entry was not accurate, and your target wouldn’t change because the market is the market.
This is why you have to start shopping for brokers with a good (low) spread when you start trying to trade on live accounts.
Because if you had been paper trading a day trading strategy and you hadn’t accounted for the spread in all of your mock trades, it’s very possible that what was a profitable strategy on paper is now not so profitable when it comes to live trading markets.
TIP: Sometimes, if you see a broker with a large spread on your broker shopping spree, always look for whether they have different types of accounts.
Some brokers have options for you to choose from as to how they will take your money. Usually, spread-based or commission-based. Which you prefer depends on your trading needs.
For example, if you are a day trader and you need a low spread every time you trade, then a commission account (usually called something like “Razor” or “Zero” accounts) that has a much lower spread but higher commission charges.
If you are a position/swing trader, maybe you don’t mind the spread because the size of your winning trades will be so big that the spread is negligible. Again… It’s up to you. One thing that is not up to you, though, is slippage.
Slippage sounds fun, right? It’s not. Slippage happens when there is volatility in the markets and price is moving is very quickly.
Some of you might have experienced trying to place your trade at one price only to get filled at a VERY different price that compromises your trade. That is slippage.
Get to know it because if you don’t, you will pay for it.
So I want to paint a picture of why exactly this happens and how spread is involved. Imagine waiting at the bus stop for a bus you HAVE TO get on.
As this bus approaches, the doors swing open, but the bus doesn’t stop. In fact, it doesn’t seem to be slowing down at all.
You would have to chase that bus down to get on it, and by the time you do, you would be very far from the actual bus stop itself.
That’s what happens to your market order. You’ve told your broker you want to get in at this specific price, so when the market moves so fast they can’t execute your order in time, you end up with a completely different trade.
This can also happen while you are in a trade. Show of hands who here has had their stop hit even though price got nowhere near it? Me too.
When market volatility increases, brokers can no longer guarantee where in the market you will get in, so they raise the spread, and if the spread rises to such a point that your stop is in the way, you get taken out.
Worse yet, sometimes the spread is beyond where you stop is, and the broker can’t get you out of the trade-in time. That is the nightmare of slippage.
Price can bypass your stop, and you have to take a loss on wherever the market fills you. That’s how people blow accounts during a currency crisis.
The funny thing is, apparently, if the same happens to your take profit (so the market/spread moves hugely in your favor), the broker will only pay out the profits you would have made at your take profit. Slippage right?
Don’t bet the farm.
Don’t lose your shirt.
Cut the L.
Keep the W.
Trading Spread FAQ
Trading spread is the difference between the bid and ask price.
The bid price in forex trading is the price at which your SELL position will execute at.
The ask price in forex trading is the price at which your BUY position will execute at.