Forex trading can be a complicated matter if people who dive into it don’t fully understand it. For starters, it’s composed of many procedures and specific terms and words that you should grasp. One of them is the spread. Some connect it to a broker in the transaction, and they aren’t entirely wrong. However, there is more beneath the surface. That’s why we dedicate today’s piece on the basics of spreads, including definitions, types, and more details. So, let’s start by dissecting the meaning of this word.
Defining Spreads
When you’re buying or selling an asset, a security, or a currency, the bidding price and asking price isn’t the same. So, simply put, the spread refers to the difference between these two prices – the selling and the buying one. That’s why another name for it is a bid-ask price difference.
The next thing which you may wonder about is how receives this spread or where it ends. Shortly, it often ends in the pockets of brokers who have successfully executed the transaction of the currency, asset, or something similar.
With that being said, things get a little more complicated when various spreads come into play. Moreover, there are several types. The type of spread you may encounter depends on a plethora of factors. One of them is the business model of the brokers, themselves. Each broker has their own way of doing business and their own model. This pretty much boils down to the way they get paid for the services that they offer to you and other actors on the market.
Types of Spreads
A Fixed Spread
To begin with, each spread has its set of characteristics, as well as positive and not-so-positive sides. After all, not everything is perfect in this world. Plus, this is a reason why both of them are found on the market and are actively used daily and by many individuals from all over the world.
Based on the business model, which we talked about before, fixed spreads are common for the market makers. Further, the so-called dealing desk brokers are able to present controlled prices. They don’t get the name market makers in vain. That’s why they are fully capable of receiving a fixed spread as compensation.
Additionally, minor traders tend to be associated with fixed spreads. These traders have a trading capital of fewer than ten thousand dollars, and very often less than that. As such, they can’t afford the risk of the variable spread.
A requote or sometimes called slippage is common with fixed spreads. That’s usually because they come from one person or one source. And it is in their interest to make a profit at all costs to survive. There are no diverse sources that are in turn characteristic to variable spreads.
Something that defines the term is the relation that this spread has with the range of bid and ask price. What’s more, when we’re talking about a fixed spread, the difference between these two prices stays the same regardless of how much time passes. That’s how the spread got its name.
Choosing fixed or variable spreads depending on the trading style is something that plenty of traders do, too. However, in the case of the fixed spread, this decision isn’t entirely a top priority. That’s because this type of spread works for all trading styles and business models.
A Variable Spread
As the name suggests, the difference price between the bidding and the asking price changes depending on the present conditions on the market unlike the case of the fixed spread. As the situation shifts, traders have to be prepared and not find themselves with empty pockets. That’s why variable spreads are linked to slightly richer traders, who may have a capital worth of more than a thousand dollars.
As of the trading styles, they may take a hit with variable spreads. In fact, there are numerous styles like position traders, day traders, scalpers, and more. And variable spreads represent a risk mostly to scalpers and day traders. That’s because the period when they stay in trade is relatively shorter when compared to the rest. So, if the price goes extremely up, they’re the ones who will take a blow and pay a higher spread.
Having said that, this type is slightly pricier when it comes to execution costs. Furthermore, variable spreads are frequently used by non-dealing desk brokers.
A Final Word
As you can see, spreads aren’t something to play with. How much you know about them can influence the sum of money you’re going to pay. That’s exactly why you should assess the situation and all the factors which will lead you to the ultimate choice.
What’s your opinion regarding spreads? Are you a fan of fixed ones or variable ones? We’re eager to hear your thoughts regarding this topic.