The Importance of Forex Spreads

By: Terry Allen

Electronic Communication Networks (ECN) offer direct access to the Inter-Bank Market by connecting you to multiple banking sources that are capable of providing you with real-time, competitive Forex quotes and spreads. In addition, as ECN brokers do not compete against their own clients, they do not have any vested interest in trade results. As such, there is less reason for this type of Forex broker to apply unethical price manipulation tactics.

Experienced Forex Traders are very selective in their choice of Forex brokers and pay particular attention to their currency spread tables. Novices fail to understand the importance of this step and, as a result, are usually attracted by brokers offering very low spreads (as low as 1 pip) for the EURUSD only. However, they normally miss or do not understand fully the important small print, associated with these offers, that states that these spreads are variable and will actually increase with volatility.

Even if they did notice this information, they usually do not understand the full meaning of this apparent throwaway statement.
As such, newcomers often fail to realise that very low introductory spreads are variable and not fixed. As such, if you do intend to use variable spreads then you must be aware that you will be particularly vulnerable during very volatile times when FX spreads have been known to increase in value by 50 pips or more especially for exotic currency pairs.

Fixed spreads are an alternative as they do not vary under any conditions. They do tend to have higher values during times of low volatility and, as a consequence, tend to cost traders more during these calmer periods. However, because you have the knowledge that fixed spreads will not change for the better or worse, you do have an advantage in that you can budget accordingly.

Consequently, you must take care in choosing a reliable Forex broker and be aware of the tricks that some unethical ones can employ to increase their profits from spreads. For instance, some brokers offer low spreads but fail to deliver by exploiting techniques such rejected trades, delayed execution, slipping, and stop-hunting.

Fixed spreads provide you with more protection against these types of problems as well as allowing you to budget more effectively. However, this is only true if you can locate an ECN broker who is fully licensed and registered on-shore, offers very competitive fixed spreads that are supported by a world class proprietary price feed.