Why do Brokers have different spreads?
In a market which is so crowded and competitive, Retail Brokers are often looking to find a way of setting themselves apart, as in truth most Brokers are offering the same service which is packaged with slight differences by creative Marketing teams. In the end Brokers are left with very little to set themselves apart, this is part of the reason why the spreads offered by Brokers are seen as a key selling point in terms of what they can offer their clients, but there is much more to a spread than many traders are aware!
The spread which can be offered by a Broker often comes down to the costs which the Broker themselves must cover before they can set a spread for their clients, these costs and the model which is being operated by the Broker are the main drivers for the setting of spreads on each currency pair. It is important to remember that most Retail Brokers will be receiving their liquidity from the same/similar sources and most should be receiving very similar spreads and commissions from their LPs, thus leaving the setting of markups/spreads for clients down to the discretion of the Broker.
Something which traders fail to realize is that the Broker themselves is often not the end point for their trades and if the Broker has their own Prime Broker (PB) or Prime of Prime (PoP), then they are paying a cost per million USD traded, which could be charged as a commission or factored into the spread. These costs, along with normal business costs must all be factored into the decision making when spreads are set by a Broker as they must ensure a profit, especially if they are a STP Broker who depends solely on markups to earn revenue.
So this brings us to our main point, how can or why do Brokers offer different spreads when they are receiving the same raw prices, below I have detailed the main reasons for differentials in spreads between Brokers:
1. Different Client Volumes & Revenue Generation – A Broker that is doing 1 – 2 Billion USD Volume a day can afford to have a lower spread than a Broker who is doing half this volume, this is due to the fact that the increased volume will allow them to earn a greater revenue overall, thus allowing them to set a lower spread in order to sacrifice some revenue in an attempt to capture greater market share.
2. Commissions – Often Brokers will choose to offset low/zero spreads with a commission, once this commission is factored into the spread you will find that this often results in a very similar spread to the competitors who have zero commissions and just a markup.
3. Different PB Costs – Not all Retail Brokers have the bargaining power to negotiate better deals with their PB’s and many smaller Brokers will have to pay higher commissions as they have lower volumes, this will result in their having greater costs and thus setting higher spreads to cover these costs. Also, PB costs tend to reduce as volume increases, thus reducing the ‘per trade’ cost and allowing a lower spread to be set. So again volume is a factor even in costs.
4. Different Models – For a STP Broker, their sole revenue is earned from markups on each trade, whereas a Market Maker knows that they will earn revenue from the spread but there is also a very high likelihood that their clients will lose, thus allowing them to set a lower spread as they have an additional source of revenue from their clients trading.
Despite all of the above, there are often scenarios whereby we see pure STP Brokers offering 0.1 pip spreads, as we recently pointed out in another article, what you see may not always be what you get, especially for Market Execution. What’s more worrying is seeing a STP Broker whom is offering a 0.1 pip spread on EURUSD without commission, we really struggle to see how these Brokers are making any worthwhile revenue on trades executed at this spread, that or they are not truly STP and your orders are being B-Booked (more common than you think). It is not very difficult to do the math for these Brokers, it is simply not feasible for a Broker to pay a Prime Broker a cost per million and to offer a near zero spread which is constant and actually executable. In many of these cases there is more to what you see than the spread and it is worthwhile getting confirmation of the PB and asking if trade tickets vs the PB can be shown as evidence of trades being pure STP.
As mentioned above, there is often a lot more behind a spread than many of us care to realize and there is a lot which can be told from looking at a Brokers model and the spread they offer. Our advice would be to focus on established, reputable Brokers who have shown consistency in both their spreads and their execution at those spreads over a significant period of time. Don’t be fooled by Marketing and certainly do your research before committing to a Broker solely on the basis of a low spread!