Forex Market Spreads Comparison
What are Market Spreads and How can a Trade Find the Best?
Market spreads are the main cost of trading incurred by the trader. Possessing some knowledge of the various forex market spreads that exist will help a trader make informed choices on which currency assets to trade based on the trading margin available to him.
A look at the instrument table of a typical retail forex trading platform will clearly reveal a table of currency pairs, and the difference in the bid/ask prices of the listed currency assets will also be clearly visible to the trader. The question is: why do different currency pairs have different spreads? To answer this question, we will compare the spreads of the different assets, understand how these spread difference came about and how the trader can put this information to his beneficial use when trading.
The difference between the bid and ask prices is the spread of the currency. In a dealing desk operated price structure, the spread is the only cost that the trader will incur during trading. In an ECN environment, there are other commissions that are paid in addition to the spread, and the commissions on each asset differ. Different currency assets have different spreads. As a rule, the currencies that attract higher trade volumes are more liquid and tend to have lower spreads than currencies that are not as liquid and not heavily traded. This is a function of the law of demand and supply. Where there is more liquidity, costs are reduced. Reduced liquidity increases costs. That is why when the forex market opens for the weekly business on Sunday, the first few hours of trading are characterized by a slight increase in the spreads of the major currencies, to reflect the status of the market as one where traders have not fully woken from the weekend slumber. As the markets pick up on Monday, the spreads drop down to their regular levels to reflect increased liquidity from greater trader participation. The following currency pairs are the most traded, and are listed in order of trade volume:
Being the most traded currency pair in the forex market, the EURUSD has the lowest spreads of all traded currencies on any platform you visit. In contrast, the exotic currencies attract the highest spreads in the currency market. Currencies such as the USDNOK attract spreads of up to 50 pips, and the pairing of the US Dollar and the South African Rand (ZAR) attracts spreads of up to 150 pips on some forex platforms.
These have trade implications for the trader, as leverage and margin requirements may make it difficult or impossible to trade certain currency pairs. Reproduced below is a table of comparison of forex spreads from a typical market maker like Ava Financial Ltd (www.avafx.com).
Instrument Old Spread New
Table showing spreads for currency pairs. Courtesy of Ava Financial Limited
The reason why we have included other assets apart from currencies is because most forex platforms have expanded their asset base to include commodities and stock indices. This is because the financial markets are largely inter-related. Indeed, some currencies have very close correlations with commodities and are known as commodity currencies. Some of these other assets have large spreads.
Currencies with low spreads have lower intraday movements. Consequently, a trader who trades low-spread currency assets will have reduced margin requirements. Intraday stop loss levels can be set to tighter levels of between 30 to 50 pips. In contrast, a trader trading the high-spread currency pairs will require higher margin requirements, and intraday stop loss levels must be widened to accommodate the wide intraday price swings. You can imagine trading a currency like the USDSEK which can swing as much as 1000 pips on a single news trade.
With this information, traders should be able to adjust their account sizes relative to the currency assets they want to trade. Traders who want to include the exotic currencies in their trading arsenal should work to expand their trading capital so as to accommodate the swings in price.
Whichever asset is traded, traders should practice responsible risk management on their accounts so that the spreads do not eventually work against them. Beginners should stay away from currency assets with wide spreads until they gain more experience.