Fixed Spreads: Your Only Guarantee in the Forex Market

In the world of forex trading, spreads are one of the most important factors to consider when choosing a broker. Each and every currency pair you trade is subject to a spread, which is simply the cost of trading a security. In forex lingo, a spread refers to the difference between the bid price and the ask price of a currency pair, usually expressed in number of pips. If you’re new to forex trading, you will quickly find out why traders are constantly on the hunt for “tight” or “narrow” spreads.

Most of the time, forex spreads are floating, which means they are directly influenced by market forces like supply, demand and overall trading activity. With a floating spread, there is no way to know for sure how much you will pay for a currency pair, but generally, the more active the trading session and/or the more exotic the security, the higher the spread.

When spreads are “tight” or “narrow,” the cost of trading is relatively low. Ideally, forex traders want the bid price and the ask price to be as close as possible. However, because market conditions can change quickly without warning, there is never a guarantee that your spread will be desirable. For this reason, more and more traders are opting for fixed spreads.

Fixed spreads guarantee that the difference between the bid and the ask doesn’t fluctuate, regardless of market conditions. If, for example, the fixed spread for the EUR/USD (euro-to-US dollar) is 2 pips, it will remain 2 pips regardless of when and under what condition you trade the EUR/USD. As such, fixed spreads do a much better job of shielding against volatility that often characterizes the market.

Two recent examples of extreme market volatility demonstrate the importance of fixed spreads in the current economic climate.

On January 15, 2015 the Swiss National Bank (SNB) unexpectedly removed its three-year-old peg of the euro, which unleashed carnage on the forex market. A simple, yet unexpected decision to remove the 1.20 floor off the EUR/CHF (euro-to-Swiss franc) exchange rate allowed the franc to surge by around 30 percent in value against the euro, pushing the EUR/CHF to record lows. The franc also gained 25 percent against the US dollar.

The impact of the decision was so catastrophic it put several forex brokers out of business, while others looked for bailouts just to stay afloat. As one would expect, such extreme volatility caused many brokers to widen their spreads significantly.

Another, more recent example is the ongoing debt crisis in Greece. For the past six months Greece and its Eurozone partners have negotiated unsuccessfully for a new bailout agreement that would keep Athens funded and part of the euro. Negotiations have been extremely volatile, resulting in a sharp devaluation of the euro and threatening the future of European solidarity.

Combined with the European Central Bank’s decision to implement quantitative easing, the Greek debt talks have seen the EUR/USD fluctuate wildly this year, including a 12-year low back in mid-March. As a result, floating spreads have been extremely volatile and unpredictable for euro pairs.

In both examples as well as many others, fixed spreads may have reduced the risks of very high trading costs that are often characteristic of a volatile trading climate. Fixed spreads add a layer of security and predictability that just aren’t available in floating spreads.

Final Considerations

Although many brokers promote very tight floating spreads, real market conditions almost ensure that you will never get what you are promised. When trading forex, fixed spreads are your only guarantee of predictability in a highly unpredictable market. This means knowing exactly how much you will pay each time you trade. Given the volatile nature of today’s economic climate, the level of security and predictability offered by fixed spreads has never been more critical. 

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This article is a guest blog written by easy-forex