Fixed or Floating?
Because FX is not “centralized”, i.e. there is no physical Exchange House or Limit Book like we see in Equities (e.g. NASDAQ, NYSE, FTSE etc.), FX pricing can “vary” from one broker to another. That said, this variance is negligible, as all brokers should be reflecting the underlying market. Supply and demand should dictate the “market price” which should be competitive yes?
Under normal market conditions supply and demand does indeed dictate the “price” of a currency pair. However there are times (as previously discussed) where heightened volatility occurs resulting in spreads widening. Such events usually occur around major news events, releases of economic data and/or breaking news (political/geo-social/natural disasters etc.). There are also times when a lack of liquidity occurs because of a “market participation”. We all recognise that the major centres for FX trading are London, NY and Tokyo which should mean consistent liquidity from Liquidity providers (Banks and Non-Bank alike). The Asian time zone (where Japan, China and Australia are the major market participants) does not have the same number of market participants as Europe or North America. This reduced number can result in less liquidity and, therefore, wider pricing.
So should I trade on Fixed or Floating (Variable) Spreads?
As a general rule a fixed spread does not change depending on time or general market fluctuations and volatility. But be warned! In instances of potential high volatility the spread may temporarily be changed. This is normally the case around the News Events we mentioned above. When the market returns to its normal condition the spread is changed back to its regular fixed spread level. It is important to remember that when a fixed spread is widened this is reflecting the actual market conditions (available pricing in the market). Each broker will have different methodology around the widening of fixed spreads so be aware of these conditions. Regardless of the widening of a fixed spread you should, in theory, be able to execute on the price without being slipped/requoted. Therefore, despite these situations, trading with a fixed spread is more convenient and beneficial for traders, as it is more predictable, and thus “less risky”. Of additional note is that a Fixed Spread account should be “commission free” as your broker is adding a Mark-Up to its raw spread it is receiving from its liquidity sources (this is how the broker makes its money).
Many brokers advertise an ECN (Electronic Communications Network), STP (Straight Through Processing) or Floating/Variable spreads account to its clients. These types of accounts should represent the very best bid and ask prices your broker is receiving from its liquidity providers which are then passed on to you. The advantage of a floating spread is that you are getting the best current market price at the time you are trading, which can often be lower than when trading on a fixed spread account. That said, it should be noted that floating spreads can also widen considerably before and after high impact news announcements and at other times of high volatility in a similar way as described above. In addition, most brokers will charge a “commission” per traded lot on a floating spread account (this is how the broker makes its money). Commission charges vary but are, nonetheless, important to know when trading on variable spreads. Why is commission important if I am trading on the best available bid and offer?
Commission vs. Commission Free
Your broker offers GBP/USD on a fixed spread account with a spread of 3 pips or a variable spread with commission at $100 per USD $1 Million traded.
Variable is cheaper yes?
· Fixed spread price for GBP/USD is 1.5377 – 1.5380; a spread of 3 pips
· Variable spread price for GBP/USD is 1.53782 – 1.53788; a spread of 0.6 pips
You sell 10 lots in fixed and variable:
· Fixed you sell 10 lots at 1.5377 and there is no commission
· Variable you sell 10 lot at 1.53782 + commission
So variable is better than fixed as you made 1.2 pips (1.53782 minus 1.5377 = 1.2 pips)!
Not so fast….
Let’s look at the commission charged on your variable spread trade:
Your broker charges you $100 per USD 1 Million traded. But the 10 lots of GBP/USD you traded is actually 10 lots of £100,000 which is £1,000,000 (not 1 Million USD $!). We now convert the base of £1,000,000 into USD: £1,000,000 times 1.53782 equals USD $1,537,820! So the commission charged is based on the USD equivalent which, in this case means you are paying USD$153.75 in commission!
If we take it a step further…. This commission charge of USD $153.75 equates to just over 1.5 pips so you have actually sold 10 lots GBP/USD at 1.53767 (1.53782 minus the 1.5 pips) so a worse “price” than trading on a fixed spread when calculating the commission cost.
Research, Research, Research
Don’t be caught out. Check to see the terms and conditions your Broker offers along with any commission charges. Cheaper is not always better! Truthfully, it should always come down to certainty of execution. Traders are, generally, fine with paying a commission to trade on the best bid/offer. But, just because your broker offers tight (competitive) spreads and low commissions, what use are they if your trade is continually slipped/re-quoted or declined?
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