There has always been an on-going debate in the Forex industry about which spread type is the best to use when trading. Some traders prefer the variable spread type due to some reasons while some traders prefer the fixed spread. We would be looking at the pros and cons of both spread models and how we can use it for our own benefits as traders in this article. But first of all, we have to know what a spread means. By simple definition, a spread is a commission charged by FOREX brokers on FOREX traders for participating in trading activities in the FOREX market. Another way of defining spread is the constant difference between the bid and ask price.
In other to understand fully what bid and ask represents in FOREX market, you should first of all understand that in the foreign exchange market prices are represented as currency pairs or exchange rate quotation where the relative value of one currency unit is denominated in the units of another currency. An exchange rate, applied to a customer willing to purchase a quote currency is called BID. It is the highest price that a currency pair will be bought. And a price of quote currency selling is called ASK. It’s the lowest price that a currency pair will be offered for sale. BID is always lower than ASK. The difference between ASK and BID is what is referred as spread. It represents brokerage service costs and replaces transactions fees. Spread is traditionally denoted in pips. In the world of Forex, the broker is going to keep the spread from each trade. This is how they are compensated and it can directly affect your bottom line. It is going to take a certain amount of the profit from each trade.
In the Forex market, there are two types of spreads that you will have to become familiar with namely a fixed spread and variable spread. A fixed spread is going to be the same for a currency pair regardless of what is going on in the market. The bid and ask price remains constant no matter the case. For example, a broker might tell you that they always have a low, fixed spread on the EUR/USD market of 1 pip. This means that even if there is not a lot of trading going on in the market, you can still place a trade and only pay them 1 pip on that pair. Many brokers that have fixed spreads will have a different spread for each currency pair while some have a particular fixed spread for all there major currency pairs. An example is Instaforex and Liteforex that offers 3 pips spread for all there majors. This spread remains the same even during economic news release announcement, bank holidays, public holidays and also Sydney/Asian session when volatility is low.
However, fixed spread brokers can be difficult to use when it comes to trading cross currency pairs in the FOREX market as the spread is always much. Fixed spreads as high as 7 pips, 9 pips, 12 pips, 14 pips depending on the cross currency pair can be charged by the broker which can sometimes turn a winning trade to a loosing trade. To some traders most especially the professionals and well experienced ones, this is not an excuse but to new bees its not going to be easy. Most brokers using the fixed spread model are called Market Makers and they operate with a dealing desk. Most news traders always prefer using a fixed spread
On the other hand, Variable spread type works in an opposite version of the fixed spread. Variable spreads will fluctuate with market conditions, they do not remain constant at any given time in the market. With this type of spread, it will be low sometimes and high at other times. Typically, during the busiest periods of the market, the spread is going to be much lower than during the slow times. Therefore, with variable spreads, you should try to trade during the London and New York sessions if you want low spreads. However, during the bank holidays, public holidays, Sydney and Asian sessions, spreads can be a little bit higher than normal. However, if you are looking to get the worst of spreads trading variable spread model, then you will want to trade during economic news reports. During these times, spreads can widen in multiple folds than the normal spread offered during normal market conditions which can be extremely dangerous. This still all depends on the transparency of the broker as there are some ECN brokers that charges very small variable spreads even during news releases times.
A good reason to trade using variable spread is trading pure technical trading as spreads on both majors and cross currencies pairs are relatively always low. Most FOREX brokers that offer reasonable variable spread are true ECN brokers that use non-dealing desk to operate. Even during news releases, spreads do not widen abnormally, maybe just 1 0r 2 pips extra from the normal and sometimes side commissions could be charged. Brokers that provide variable spreads are giving you a direct feed into the Forex market. If you want to work with a real broker that processes your orders directly into the market, you will have to deal with true ECN variable spreads in most cases. This can make your trading a bit unpredictable, but it is giving you direct access to the market.
In conclusion, both fixed and variable spread are good spread types to use when dealing with Forex brokers in the Forex market. However, before selecting one of the spread model, consideration has to be made majorly on which strategy type one uses in trading. A technical trader that trades intra-day would want to opt for the Variable spread while a fundamental trader would like to trade with a fixed spread type or true ECN variable.