Spreads are a critical feature to consider when selecting a forex broker in the field of forex trading. This is because each currency pair you exchange is exposed to a spread, which is equivalent to the cost of protection trading. If you’re new to currency trading, it’s easy to understand why traders are always on the lookout for fixed spreads. When spreads are fixed, trading costs are low. In an ideal world, forex traders would like the offer and ask prices to be as similar as possible. In this article, you will get to know about fixed spreads: your only assurance in the forex sector.
What are Fixed Spreads?
A spread is a disparity in price between both the ask and bid. For example, consider a supplier that purchases a commodity at a wholesale cost and then sells it at a markup. Depending on the uncertainty, some brokers change this difference between both the ask and bid prices. Thus, if prices are unstable, your spread can vary for each trade you make during that time span. Read the LMFX review to understand how complex it is to calculate variable spreads.
On the other hand, fixed spreads allow you to know your spread price in advance and build your approach (long-term or daily) more easily. This results in increased market transparency and, eventually, a more accurate cost evaluation before trading begins.
Variable vs. Fixed Spreads
Spreads are classified as variable or fixed in forex trading.
A variable or floating spread is the difference between the ask and bid prices that is continuously changing. In other terms, the spread you pay when buying a currency pair varies according to production and consumption, as well as overall market volatility.
Brokers that advertise fixed spreads often sell variable spreads. Although it is likely that the spread you purchase suits the broker’s marketed spread, that isn’t always the case. Spreads are typically narrower throughout active market sessions with optimum liquidity. The London-New York overlap is a perfect example of this. After all, variable spreads are a business trend.
How do Fixed Spreads Help?
Fixed spreads to ensure that the gap between the bid and ask prices remains constant irrespective of market dynamics. If the EUR/USD (euro-to-US dollar) fixed spread is two pips, for example, it will stay two pips regardless of whether or under what conditions you exchange the EUR/USD. As such, fixed spreads are much more effective at mitigating the market’s uncertainty.
Two recent instances of excessive market uncertainty highlight the critical nature of fixed spreads in today’s economic environment.
Example 1
On January 15, 2015, the Swiss National Bank (SNB) abruptly abandoned its three-year-old euro peg, triggering havoc on the foreign exchange market. A straightforward yet surprising decision to eliminate the 1.20 floor from the EUR/CHF (euro-to-Swiss franc) rate of exchange caused the franc to appreciate by approximately 30% against the euro, sending the EUR/CHF to new lows. Additionally, the franc rose 25% against the US dollar.
The decision had such a devastating effect that some forex brokers went out of practice, while others sought bailouts to keep afloat. As one would imagine, such explosive growth forced many brokers to expand their spreads dramatically.
Example 2
A more notable example is Greece’s current debt crisis. Greece and its Eurozone allies have been negotiating indefinitely for six months for a new loan deal that would keep Athens supported and a member of the euro. However, discussions have been tense, precipitating a dramatic depreciation of the euro and jeopardizing the future of European integration.
When combined with the European Central Bank’s decision to introduce a monetary stimulus, the EUR/USD has fluctuated wildly this year, reaching a 12-year low in mid-March. As a result, floating spreads on euro pairs have become extremely chaotic and uncertain.
In each of these instances and many others, fixed spreads may have mitigated the risk of extremely high transaction costs, which are often associated with a volatile trading environment. Additionally, fixed spreads have a level of protection and dependability that floating spreads do not.
The 5 Advantages of Fixed Spreads
- More Transparency
Fixed spreads imply direct costs in forex. This is because you already know precisely what you’re going to spend, irrespective of currency exchange volatility, time of day, or trading rate. This prevents brokers from manipulating spreads to their advantage.
- Lower Costs
By using fixed spreads, you will substantially lower your trading costs. Additionally, fixed spreads eliminate surprises, allowing you to prepare for transaction costs well in advance. This will significantly enhance your capacity for cost management throughout your trading career.
- Easier News Trading
Volatility has become ingrained in the forex market and is no longer confined to news coverage. Although variable spreads can be advantageous during quieter market periods, fixed spreads are optimal during market fluctuations, often offering additional opportunities to profit from.
- Safeguard Against Volatility
Regrettably, variable spread transactions can render news trading extremely confusing due to the extensive range of bid and ask prices. Therefore, traders should treat news trading in the same way they would any other state of the market by using a fixed spread.
- More Effective Short-Term Strategies
Short-term forex trading strategies include making multiple trades in a short amount of time – it is significantly simpler and more consistent to do so with this. Additionally, since the possible benefits are limited in this approach, using fixed spreads provides a higher degree of market clarity.
Conclusion
While many brokers advertise extremely low floating spreads, current market dynamics almost guarantee that you will never receive what you are insured. Fixed spreads are your only assurance of certainty when trading forex in a highly volatile environment. This entails understanding precisely how much you will pay for what exchange. It is crucial to identify the reasons that contribute to the spread widening when trading forex. Major currency pairs are exchanged in large quantities to maintain a tight spread, while exotic currency pairs have a broader spread. With today’s economic environment being so unpredictable, the degree of stability and predictability provided by fixed spreads has never been more critical.
