Fixed Spreads vs. Variable Spreads
When looking for a prospective broker, it is important to research how they price their spreads. Over time, the spreads that a trader pays ends up costing a significant amount, and should be a key consideration when choosing a Forex broker.
Forex brokers generally offer two types of trade spreads, variable or fixed. So, which is the better option? Opinions differ amongst traders and it does depend on individual trading styles. First, let’s look at the difference between the two spread structures.
With variable spreads, the difference between the buy and sell price of a particular currency pair fluctuates in a range. A variable spread for the EUR/USD pair generally differs between 1 to 4 pips for most brokers, but during volatile market conditions can actually widen to as much as 8 or even 10 pips.
A variable spread widens in correlation with increased liquidity in the market and is really only low during times of market inactivity.
On the other hand, fixed spreads are predetermined and remain constant throughout all trading conditions. A fixed spread will usually fall within the range of a variable spread, and is commonly set at either 2 or 3 pips for EUR/USD.
Though traders essentially pay a small premium during quiet market hours, when a variable spread may be lower, the broker ensures that the spread will not widen during even the most volatile market conditions. Fixed spreads allow traders to better strategize without factoring in an unpredictable variable that inflates transaction costs during times most critical to traders.
Quiet versus Volatile Markets, What Kind of Trader are You?
Variable spreads may be more suited to long-term traders who do not trade during news events and are prone to entering and exiting during quiet market conditions.
This way they can more consistently obtain a price that is in the lower range of the variable spread.
For example, if a trader were to enter the market during off-peak times with a variable spread of 1 or 1.5 pips on EUR/USD as opposed to the fixed 2 or 3 pip spread on many platforms, he would save money on the spread in the long run.
100 trades at 1 pip (or 1.5 pips) = $100 ($150) in spreads
100 trades at 2 pips (or 3 pips) = $200 ($300) in spreads
However, flat markets and off-peak times are periods of consolidation when it is less clear where the price will head next. Most traders prefer to place positions when a clearer direction is evident in the market.
During swift market activity, especially around important fundamental releases such as a speech by a central bank official or the opening of local business hours and stock exchanges, spreads are widened to the upper part of their ranges.
Likewise, during breaks of key technical leves, the market may also be very volatile sometimes moving as much as 100 pips in as little as 5 minutes.
During these vulnerable times, opening positions becomes more expensive, which can be a deterrent to trading.
Variable Spreads and Stops
Variable spreads may even set off protective stops and limits unwittingly. If the difference between the Bid and Ask widens and reaches the level of a stop or limit, this large gap may suddenly execute a conditional order. This adds an extra variable to your strategy that you need to consider.
This might be less likely to occur with fixed spreads because the Bid and Ask are always synchronized. Fixed spreads minimize the element of surprise; traders know exactly what the parameters are at all times, allowing for better strategic planning and money management.
Tight, competitive spreads affect your bottom line as a trader, and the best spread structure for you depends on your trading style, appetite for risk, ability to react in a fast-moving market, and ultimately, the quality of execution.
Fixed spreads are consistent and predictable regardless of market liquidity. On the other hand, variable spreads tend to provide lower costs only during quiet market conditions—times of limited market activity when traders may have less incentive to trade.