What is a spread in Forex trading?
One of the key concepts of Forex trading is spread. Experienced traders are already familiar with this term, and it will be useful for beginners to learn the features of this phenomenon, since a deliberate approach to the trading process will allow novice traders to avoid common mistakes and increase their income. Probably, many of our readers have heard such a word as “spread” in the context of currency trading in Forex. Today we are going to tell you how to optimize your actions for certain spread values and how to organize your Forex strategy more profitably.
In a general sense, spread refers to the price difference between buying and selling a trading product. If we are talking about Forex trading, then one of the most popular currency pairs is doubtlessly EUR / USD. Indeed, what is the reason for such a high demand for the euro-dollar pair in the Forex market? The choice of many traders is by no means accidental: when dealing with these currencies, the difference between buying and selling is usually not very different, that is, the spread is quite low. Is this good for a trader themselves ? Let’s take a look at this issue in more detail.
Most economists are of the opinion that the spread is a clear indicator of the liquidity of a particular market. Brokerage companies, which usually charge a commission for their mediation in traders’ transactions, try to maintain the spread at an acceptable level for both parties. If the spread is very high, then this may serve as an indicator of low market liquidity. Currently, such a situation is observed in the natural gas market, therefore, the amount of commission charges from the broker in relation to the trader will be higher here.
So, our today’s material will help you analyze the reasons leading to an increase or decrease in the spread in Forex, therefore, a thoughtful understanding of this issue will help you in terms of self-education and development of trading skills. How to understand how high the liquidity of your Forex trading is? Can the spread depend on the trading volume and market conditions? We will provide the most complete and detailed answers to all your questions. Do you want to become an expert in Forex trading? Then our review about the reduced spread will be very useful to you.
Factors influencing the decrease in the spread
Spread is a dynamic value that tends to change under the influence of a number of circumstances. Naturally, the trader is interested in the reduced spread when making transactions in Forex. However, how to achieve this if you do not know the reasons provoking a rise or fall in the spread in Forex currency exchange? There are many factors causing an increase or decrease in the spread, however, the following three are usually distinguished among them, because they play the main role here:
- market conditions;
- volume of traded funds;
- liquidity of a single market.
Let’s pay attention to the first item of our list. The conditions that the market dictates can significantly affect the size of the spread. The market itself is like a living organism with certain life cycles. It is far from always possible to predict how a trader will trade in Forex on a particular day and whether it will be successful, but there are signs that can be relied on when building financial forecasts in the foreign exchange market as a whole. The stability of the market is strongly influenced by macro- and microeconomic events, and, hence, the size of the spread in Forex.
Perhaps you are interested in the answer to the question, is there a concept of a low spread outside Forex trading? Every trader benefits from broadening his horizons, so it is useful to know that a decrease in the spread can occur both in the banking system and in the stock markets. If economic conditions are favorable, then the lender can release funds to the borrower at a reduced interest rate, which also leads to a decrease in the spread. In the securities market, the spread narrows if the market maker decides to buy shares when there are no other candidates to buy them.
As a rule, more often the spread is calculated not in currency indicators, but in points. During major international or domestic news that affects all spheres of industry and human life, the spread widens and it can reach several points, which is unprofitable for a Forex trader. Trading in such periods is characterized by high volatility, and it is impractical to expect a decrease in the spread in such a situation.
Another reason that affects the size of the spread in the foreign exchange market is the amount of funds traded. The question that the trader faces is: is it possible to have a reduced spread in Forex? Our answer will be: yes, it is possible to achieve this, but the spread may become lower if the trading volume is higher. Accordingly, this ratio provides higher market liquidity, and we will talk about it below. So, if you make a large number of transactions in Forex in one trading session, then the quantity will affect the quality, that is, the total size of the spread will be lower.
And finally, we have come to such a factor as liquidity. As mentioned earlier, the spread is always lower in the most liquid markets, so Forex trading can bring the maximum profit to a trader if they use the most promising and popular currency products, for example, euro, dollar, bitcoin and other cryptocurrencies, that is, those currencies, which set the level of market liquidity. And vice versa: the more problematic trading in an illiquid market, the higher and more undesirable the spread indicators. It follows that the best option would be to choose a market with good liquidity for a reduced spread.
The value of the reduced spread in Forex trading
A reduced spread size can have a positive effect on the amount of a trader’s income. There are a number of nuances that you need to pay attention to when choosing a broker if you want to carry out your trading activities through a dealer organization. Depending on the style of Forex trading you choose, the spread is important directly for your account. If we are talking about day trading (or scalping), then the definition of the spread will be the difference between your estimated profit and the losses incurred.
It is desirable that the spread in such a situation remains rather low, however, if you have insufficient experience or incorrectly building a trading strategy, the spread may increase by any number of points. How to reduce the spread in Forex? First of all, in day trading, it is worth choosing the most proven instruments and planning the algorithms used correctly. In addition, it is useful to remember about the number of trades and the liquidity of the selected market, then the spread will be minimal.
Reduced spread in Forex is the aspiration of many traders. However, how is it that for beginners, the spread often reaches quite impressive indicators? The answer may lie in the following reason: inexperienced traders want to make significant profits in a short time. Unfortunately, it must be admitted that a considerable number of newbies do not read books about successful Forex trading from leading experts in this field. Not everyone has an understanding of such an important aspect as the influence of trading style on the size of the spread.
The strategic blunder of newcomers to Forex is that they start trading too aggressively, without detailed calculation of their every move, as if they were playing chess. Aggressive Forex trading strategies increase not only the risks, but, of course, the spread, which often negatively affects the state of the trader’s deposit. In addition, if slippage occurs during aggressive trading, then it will be difficult to achieve a reduced spread in Forex under such circumstances. Perhaps it makes sense to reconsider your trading strategy in order to lower the spread.
How to reduce the spread in Forex?
As we discussed this aspect above, there is an interconnection between the Forex trading strategy and the spread indicators for a particular trader. Depending on which strategy you are following, you need to understand which group of traders is most vulnerable to spread fluctuations. Let’s say you’ve tested various strategies for some time and came to the conclusion that swing trading is right for you. If this is a convenient style for you, then the general picture is that the key here is the accumulation of pips, that is, an increase or decrease in the spread may not have a significant effect on profit.
Nevertheless, if you are a day trader, it is possible to keep the spread under control by timely use of the Take Profit buttons and, of course, Stop Loss. It is extremely important to get the already existing profit and manage to stop the increase in losses in order to prevent the growth of the spread in Forex. Perhaps many beginners notice that negative dynamics is often observed on the chart when opening a position. This is precisely due to the increase in the spread, so it is necessary to monitor the course of events in the process of making a transaction in Forex.
Another important point when trying to reduce the spread is the trading signal. Forex experts recommend not to trade when the spread is too high. How to understand this if a trading signal to enter a trade has already arrived? In this case, it is worthwhile to devote some time to observing the time intervals when the spread increased and simply not to conclude any deals specifically in this period of time, but to wait for more favorable conditions for trading in Forex.
Summing up our today’s review, we would like to summarize the key parameters that will help reduce the spread for any trader, in particular, a beginner in Forex. First of all, you should always pay close attention to factors such as market liquidity and selected financial instruments. Next, you need to remember about the terms of trade, created or already present in this market. If the market is not characterized by high liquidity and is in a crisis state, then it is better to take a closer look at those Forex trading options that will definitely bring profit against the backdrop of a reduced spread.