Currencies Trading Spreads – What They Say About the Market
When musing on the trade of forex, we’re talking in spreads and pips. That may sound like a bunch of buzzwords you as a newbie have yet to discover, so let’s go into some detail around these two forex features.
So, what is spread in currency trading? Well, that’s a great question, because essentially spreads are the primary cost of trading currencies. To define the notion further – spreads are the price difference between where a trader may purchase an underlying asset, and where he or she may sell.
And so, what’s a pip in relation? A pip – or point in percentage – is the unit of measure that indicates the smallest change in value between currencies. Essentially, the measurement of the spread.
What factors affect currency spreads?
To better understand how a spread affects a trade, let’s look at the factors that make spreads that are high, and spreads that are low. Spreads can fluctuate between the two states throughout the day, depending on the volatility of the market and the liquidity of the currency. So, for example, emerging market currency commands a much wider spread, than established currencies, and that’s simply because major currencies trade in high volumes – higher trade volumes mean lower spreads.
Then there’s the economic state to which the currency belongs. If major news events happen, natural disasters, wars, and political dealings, for example, these may shift the volatility of the currency higher, and so the currency spreads often tend to widen too.
A high spread is a large difference between the bid on a currency, and the asking price. A higher spread, then, shows high volatility within the market for the currency, and usually low liquidity.
A low spread, conversely, means a small difference between the bid and asking price. A low spread generally means lower volatility in the market, and higher liquidity for the currency.
Best strategy for trading when there is a significant spread between the buy and sell prices?
So, to summarise:
- Spreads are based on the buy and sell status and price of a pair of currencies
- Forex spreads are variable
- Costs in forex trading are based on the spreads and lot sizes between currency pairs
But now that you know that, and you have a better understanding of spreads and pips dictating liquidity and volatility, what’s the best strategy to go about trading forex when the spread is significant?
Day trading is precisely what it says on the box – the trading of forex currencies in a day. Day traders will base their strategies on the news of today, to determine volatility and liquidity in currencies, and to determine their spreads. The news events that mostly affect day trade spreads, are elections, conflict in a country, economical movement, and of course interest rates. To minimise risk, day traders close positions before the end of the day, and usually set a daily risk limit of 3%. When spreads are wide, this is the best strategy to mitigate risk in a forex trade.
So, that’s a very quick rundown of spread in currency trading, why it happens, and the fact that trading strategies can be distinctly modified to align with these spreads, and the pip percentage that results. As usual though, and like we’ve talked about before, it’s about getting to know the machinations of the trades in forex that will work best for you. So, sign up with QuickTrade and MetaTrader 5 today, and get a trading demo account that’ll show you how to build your trader’s strategies around the various market spreads that can arise in forex, for the highest chance of success.
Click here now to find out more and start trading today.