Spreads In Forex Trading
BEWARE OF THE SPREAD!
Often, traders and investors miss the small but MAJOR details before making a decision when purchasing a stock or a certain currency. Forgetting to check the spread on a Forex pair is normal when you see an opportunity and just want to pounce, but the disadvantage is yours and yours alone. That we will tackle later on.
So what is spread? Spread is the difference in price between the buy (bid) and sell (ask). This amount can widen or narrow drastically, depending on several factors.
Being aware of the Forex pairs spread will help manage the cost of trading. The wider the spread the greater the cost to enter that trade. Please also remember the higher your leverage, the higher your trading costs will be and that may cause a decline in equity. For beginner traders, it is important to be wary of spreads (especially if you are starting with a small account).
Components to consider in Forex
There are a few components to keep an eye on when it comes to the spread of a currency pair. Let us dive into them below.
1. Look out for the factors that affect the changes in spread.
Liquidity – When the market is illiquid, spreads will usually widen. Volatility and liquidity are interconnected i.e. one can trigger a spike or decline in the other, which then affects the spread of Forex pairs. Emerging market currencies are considered to be illiquid markets for example USDMXN (United States Dollar against the Mexican Peso). That Forex pair usually has high spreads due to low liquidity.
2. Trade high liquidity Forex pairs
This means trading your major pairs; EURUSD, GBPUSD, USDJPY, and USDCHF. These pairs will usually have low spreads because they trade in high volumes. High volatility events are what cause the spreads of these pairs to increase.
(Source – Daily FX)
Please pay attention to the black boxes. In these boxes, you see the spread. As shown, the spread of the major pairs is far less than the spread of the minor (exotic) Forex pairs.
3. Time of the day
The time of day at which you trade usually affects the spread of Forex pairs. The best time to trade would be around the major trading sessions, considered London and New York sessions respectively. Around those times, spreads are usually at their lowest.
Why high spread is bad
Now the disadvantages of high spreads I was talking about!!
1. You pay more to place a certain trade, which may affect the profitability of that particular trade.
2. Your liquidity is diminished faster with high spreads.