subject: Fx Trading - Fixed Spread Vs Variable Spread [print this page] 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. Thus, this ought to be one of the main determinants when choosing a brokerage firm out of the many available out there. 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.
A major advantage of fixed spreads is that they make entering a trade cost effective, particularly when there is a lot of activity in the market and interbank spreads increase. 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. On the contrary, when you trade using fixed spreads, you are likely to increase your transaction costs when you are in a market with low liquidity.
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 example, in times of low liquidity, the spread for the aforementioned EURO/USD pair can be less than 2 pips, may be 1.8, which makes for low-priced transaction costs that can prove to be of great benefit to your trading. Conversely, during times of important news releases, variable spreads increases as the quantity of orders reduces in the marketplace.
As an example, during the monthly release of the U.S. Non-Farm Payroll data, you can observe that the EURO/USD pair has a spread of ten pips. Thus, this makes variable spreads hard to trade with when you are in market conditions that are changeable and mercurial.
Conclusion
While it can be difficult to choose between fixed spreads and variable spreads, the choice you make will rely on your trading style, risk appetite, ability to react favorably in very liquid market conditions, and, ultimately, the speed at which you are able to effectively place orders in your trading station. Nevertheless, it is advantageous to use fixed spreads if you like trading in times of high liquidity in the marketplace, such as during the overlap of two trading sessions or during, or just after, the release of major economic report.
Therefore, you should use fixed spreads when scalping. And, variable spreads are the most appropriate if you are a long-term trader who does not depend on the release of vital fundamental data for trading.
by: Ownen Moore
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