What Are Forex Spreads and Low Spreads?
What Are Forex Spreads and Low Spreads?
Market trading is an exciting way to see how far you can take the returns on your money in a global market. And there's nowhere better to be doing it right now than in the Forex market.
With thousands of trades taking place every day, the market for foreign currencies is robust and has a lot to offer. But it's important to know what you're doing, and why.
Today, we'll be taking a look at fixed, variable, and, perhaps most importantly, low spreads, and showing you how these can be used in your trading.
You, Forex, And Low Spreads
It's safe to say Forex trading is more popular than it's ever been.
Foreign exchange is hardly a new concept, but, for many traders, the concept is a little unfamiliar. It's hardly surprising - for many years, the place to make these kinds of transactions was the stock exchange.
In recent years, more traders have become frustrated with the volatility of traditional stock trades. As a result, Forex brokerages are starting to become more popular.
But how does it work? What's at the heart of Forex trading, and how are people using that to make returns on their investments?
The answer is in the forex spreads.
Forex Spreads
Let's start with the basics.
A Forex spread refers to the difference in price between what your broker buys currency from you for and the price at which they sell it.
By way of an example, we'll make up a currency: the Smiley. You have a broker who's willing to buy your Smileys from you for 100, and sell them for 100.05. What we see here is a spread of .05, which is profit that goes to the broker.
Simple enough, yes?
Well, then we get into the question of supply and demands. What makes the Forex market competitive is the specific weights of each currency being traded on it.
Let's say you're not trading in smileys. Let's say, instead, you're trading in American dollars. Now the currency has a different feeling to it - it's a big name, a real industry player, and everyone is trading in it.
There's no shortage, which means the broker can charge less for each dollar, because they know they can sell more of them, overall, and still make money. The spread will almost definitely be smaller, and your chances of selling them more reliable.
Conversely, say you're trying to trade a less common currency: the Atlantis sea token (another currency we just made up).
Demand for this will not be high because where (except for Atlantis) will this token ever be used? Very few people need it, and your broker is taking a bigger risk trying to move it, so they'll have to charge more for it. The spread is bigger, here, and your investment is much riskier.
Let's take a closer look at fixed and variable spreads, and some of the potential risks of opting for low spread services.
Fixed spreads
These spreads are locked in at a specific value and will not change with time or fluctuations in the market. The rate you buy in at is the rate you'll get across the board.
There are exceptions to this rule. In cases where liquidity is low and the market is volatile, spreads can be temporarily transferred to new packages, at adjusted levels. It's important to note, though, that this is rare, and when the market regulates again, these spreads return to their original amounts.
Fixed spreads are considered more beneficial to clients, as there's less risk involved. It may interest you to know, though, that they actually run your trade a higher cost, due to insurance costs on each trade.
Fixed spreads are typically set at between two and three pips per transaction for Euros and American dollars. With fixed spreads, traders can devise better strategies, without worrying about trade variables.
Variable spreads
Variable spreads may be closer to what you imagine when you picture a market based on currencies which, themselves, have sliding values.
Here, the difference between buy and sell prices fluctuates based on that currency's value. It can dip and raise based on factors out of your control, making it a more volatile investment.
In terms of numbers, variable spreads for Euros and American dollars typically fall between one and four pips, depending on the broker. As we've mentioned, though, this can widen greatly during volatile periods in the market, to as much as ten pips. Theoretically, it could go even higher than that. See here.
The only time a variable spread is ever objectively low is during times of market inactivity.
Low Spreads
Forex trading is the buying and selling of currencies, specifically.
Many people make the change to Forex after being frustrated by the volatility and expense of stock market trading.
When people turn to Forex, part of the reason is because brokers don't charge traditional commission fees.
They charge spreads, like the kinds we've mentioned above. These are amounts of money equal to the difference between how much the broker pays for your single unit of currency, and how much they'll sell it for.
It's understandable: after all, brokers need to make money, too, or why bother being in the industry? It's a business, and everyone needs to take home something.
So, as a seller, it makes sense to aim for low spreads, right?
Well, not always.
Obviously, all of this depends on the broker themselves, but, as we've mentioned, they have to make money somehow. Lower spreads from brokers often come bundled with commissions, so that the broker can recoup their expenses.
It's important to ask about this before you start, so you aren't surprised.
High Or Low Spreads: It's About What You Put In
Ultimately, Forex is like any other trade market: how much money you spend, and how much of it you risk on fluctuations, is up to you.
Fixed spreads can remain low, and are more dependable. Variables, meanwhile, can mean higher spreads, but the potential for better returns.
Speak to your broker about what works best for your personal finances, and make sure to do your homework before committing to a specific trade.
Want to make the best return possible on your Forex trades? Read more about forex spreads here: https://en.wikipedia.org/wiki/Spread_trade.
