How important are Fixed Spreads

The currency markets provide amble liquidity to investors interested in speculating on currency exposure. Most of the dealers and brokers who participate in these markets provide clients with a two way market allowing them to enter and exit when they want. Many investors take this for granted but might be very surprised when they attempt to exit a position if the spreads they normally see are wider than expected.

To enter or exit a currency position a traders needs to purchase or sell a currency pair. To purchase a pair, a trader needs to buy from a broker and the price where the broker is willing to transact is called the offer or ask price. Brokers are willing to buy a currency pair at the bid price. The spread between these prices is known as the bid offer spread. While many platforms and brokers offer fixed spreads where the difference remains constant despite volatility within the capital markets, the majority of dealers have variable spreads that may change at any time.

One of the most difficult numbers to calculate when evaluate a trading strategy is the slippage you might face when trading a currency pair. If your strategy is a scalping strategy where you are attempting to take a small amount out of the market on every trade, you need to rely on constant spreads to achieve success. For example, if you are always trying to take 10 pips out of the market, you need the ability to calculate your costs. If the spread is always 5 pips then you know you can make money when you speculate correctly. If the spread can vary from 3 pips to 15 pips, then despite creating a successful strategy you cannot rely on this to be profitable based on the variability of the spread.

Dealers will incorporate variable spreads for a number of reasons. The most common is based on the volatility in the currency market. If currency markets are whipsawing, a broker might consider widening their bid/ask spread in an effort to protect themselves from wild swings. Another reason a broker might consider widening their bid/ask spread is they hold too many positions in one direction. For example, if a broker is long EUR/USD but does not want to take on more risk, he might widen the bid/offer spread making it unattractive for a trader to sell more of the currency pair to him.

Finding a broker or platform that offers fixed spread may help you secure a trading strategy and partner that will provide you with the liquidity that you need to successfully implement your trading strategy. You will not have to wonder whether you will be able to exit, and you can concentrate your speculating on the actual market as opposed to whether your broker will adjust his spread.

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