In this article, we will be looking at the various factors that could cause a spread to widen or narrow and make them work for us as traders.
Remember when we mentioned that a benefit of trading on Forex was that the broker placed no commission fees or charges, unlike with stocks? What about poor brokers? How do they make their gains then? The answer is simple.
Spreads. In return for carrying out buy and sell orders for investors in the market, brokers will charge a commission per trade. However, this fee is not separate but built into the ask and bid price of the currency you wish to trade.
How Does it Work?
When you wish to buy a currency, they will sell it to you for more than they paid to buy. And if you want to sell the currency, they will buy it from you at a price less than they will receive when they sell it. The difference between these is called the Spread.
It makes sense from a market point as the broker is providing a service, and he must make his gains.
Economic releases, as well as geopolitical events, can cause a spread to widen. There are so many possible economic events that could take place that can cause a spread to widen. For example, suppose the unemployment rate for a country comes out higher than expected by the market. In that case, it could cause that nation’s currency to weaken against the value of other countries’ currencies. These periods usually cause the exchange rate to fluctuate wildly, resulting in wider spreads. Also, in the case when a country decides to increase its interest rates. Traders will like to trade with that nation’s currency, which could lead to spread on pairs with such currency to narrow. Hence as a trader, you need to keep an eye out for releases and news that pertains to the economy of countries whose currencies you trade with.
Liquidity and Volatility are two concepts that are intertwined with one another. Markets with high liquidity tend to have a stable economic environment and high liquidity pairs tend to have lower spreads. However, markets with low liquidity or illiquid markets tend to cause Volatility, and illiquid pairs tend to have higher spreads.
As a trader, it is advisable to trade with pairs that have high liquidity. These can be found among the major currency pairs like the GBP/USD, USD/JPY, EUR/USD. These pairs usually trade in high volumes; hence they will have lower spreads. However, it is crucial to note that these pairs do not always trade at low spreads because they are subject to Volatility, liquidity, and economic news, which could lead to a widening of spreads.
Emerging currency pairs like the USD/ZAR, USD/ CHF, and the likes tend to have higher spreads than the major currency pairs. Thus as a trader, it is advisable that if you wish to trade with these pairs, you do so with little to no leverage at all.
Time Of Day
Choosing the right time of the day to trade can be a huge boost to a trader’s strategy. This is because the time of the day when a trade is initiated is critical. Due to the different time zones of countries worldwide, as a trader, you need to look out for the regular trading session for the country whose currency you are trading with. During major trading sessions, spreads are usually lower because there are many traders on the market, leading to easy buying and selling of the currency. This, in turn, will yield high liquidity in the market, which would lead to lower spreads. So as a trader, be mindful of these significant trading sessions and when they begin in your country of residence so that you can capitalize on them.
With all this information from our beginner’s guide to Forex, you’re just a step away from navigating the Forex market.