When you are planning to start a business in Forex trading, it is of essence to understand how the many brokerage firms available out there price their spreads (the difference between the bid price and ask price). Understanding the difference between fixed spreads and variable spreads can enable you to save a significant amount of your money. Therefore, this should be your major deciding factor when picking your preferred Forex broker. Here are a few pros and cons of each type.
Fixed Spreads
In a fixed spread, the broker always guarantees that the spread will not change regardless of what is taking place in the market. For instance, a broker might inform you that their fixed spread for USD/JPY is three pips per trade. This implies that even when there is high volatility in the market, such as during major news announcements, or when the market is thinly traded, you are still able to enter a trade and pay them three pips on that currency pair.
Using fixed spread to trade is cost effective, especially when you are trading in volatile market conditions when the interbank spreads tend to widen. Fixed spreads allow you to organize better your trades irrespective of the unforeseeable events at the market place that most of the times inflate the transaction costs. In contrast to variable spreads, trading using fixed spreads increases your transactions costs in a thinly traded market.
Variable Spreads
A variable spread tends to fluctuate in a range depending on the market conditions; that is, it would be low sometimes and high at other times. When the liquidity in a market increases, such as the overlap between the London and New York sessions, variable spread increases. And, during low market times, such as at 6 p.m. eastern time [ET], when New York is closed and Asia is not yet fully opened, the difference between the bid price and ask price decreases. Therefore, this makes your trading through variable spreads less expensive on the whole.
However, it comes with the risk of changing market conditions that can increase them at any time. For instance, during low market conditions, the spread for the above-mentioned USD/JPY pair can be lower than three pips, maybe two pips, which makes for less expensive trading costs that is always advantageous. Conversely, during times of important news releases, variable spreads increases as the quantity of orders reduces in the marketplace.
For instance, during the Non-Farm Payroll announcement in the United States, you can find that the USD/JPY pair has a spread of up to twenty pips. Thus, this makes variable spreads hard to trade with when you are in market conditions that are changeable and mercurial.
Conclusion
The better option between a fixed spread and a variable spread depends on the style you employ in trading, tolerance for risk, capability to react in extremely volatile market conditions, and, eventually, the quality of execution of orders in your trading platform. Nonetheless, it is advisable you use fixed spread if you like to trade during swift market activity, particularly when there is an overlap of two trading sessions or during the release of vital fundamental data.
Thus, fixed spreads are best suited for scalping. And, it is advisable you use variable spread if you are a long-term trader who do not like trading during the release of important economic news and data.
In the end, it highly depends on your trading style. If you're a scalper, I could suggest a broker with good low fixed spread: 4RunnerForex review. If you prefer long-term trading, I'd suggest an ECN broker with low variable spread: AAAFx review.
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