Forex CFD Trading: Fixed Spreads or Variable Spreads

Q:What is the spread in Forex CFD Trading?

A: Did you know that the foreign exchange market is the largest financial market in the world? An estimated $4.0 trillion is transacted every day, making it over ten times larger than the combined value of daily trading on global stock markets. For those active and sophisticated investors aiming to profit from exchange rate movements CFDs provide a good way to speculate on the forex markets.

What is the Spread?

Spreads are much more frequently talked about when discussing index and forex CFDs than share CFDs, however it is worth noting that spreads are used on all manner of financial instruments including exchange traded and OTC financial products, although they’re not always referred to as such.

When you’re using CFDs to trade in currencies you will be concerned about the size of the ‘spread’. The spread amounts to the difference between the price you can buy at and the price you sell a forex pair at, which means that as soon as you have opened a trade, the prices have to move in the right direction by the amount of the spread before you can break even. As this happens on every trade you make, even though differences in spreads between brokers may be small the size of the spread can still substantially impact your profit.

In principle, the spreads on CFDs reflect the buying and selling prices of the underlying financial instrument, but in practice, unless you have direct market access (which is not always available for all markets) you may find that the spreads will vary from the rates that you can look up. Some of these variations may cover the cost for ‘commission free trading’.

Having said that, since the forex market is the largest market in the world, there is a vast amount of liquidity and spreads tend to be very tight (especially for the popular forex pairs) meaning that buying and selling prices are usually very close. For this reason forex prices should usually mirror very closely the movements of the underlying market.

Q:What are better for Forex CFD Trading: Fixed Spreads or Variable Spreads?

A: You will find two different approaches from CFD providers towards the size of the spreads. Some providers will advertise that their spreads are fixed, and they will always have the same difference between the buying and selling prices. Other providers offer variable spreads which may be tighter at some times of the day and wider at others. The larger spreads are usually quoted when there is more volatility and the CFD provider is concerned not to be caught out by a sudden currency pair price swing. Conversely, you can expect to see smaller spreads when the market is quiet and fairly predictable.

If you choose a provider who offers fixed spreads then you don’t have to worry about re-quotes or spreads widening during periods of high volume. You are also generally able to compute your profits or losses more accurately as you aren’t at the mercy of the CFD provider.

If you normally trade when the market is active and liquidity is optimal (especially during the first hours of the London-New York markets overlap when the bulk of market participants are operating), then, you may find that the variable spreads offered are better than those available on the fixed spreads market. On the other hand, if most of your trading takes place during volatile periods, then trading forex CFDs on fixed spreads can be advantageous over variable spreads particularly in periods of high volatility where providers offering variable spreads will quote exceptionally wide spreads, however trading during periods of low volume fixed spreads will ultimately cost you more. In periods of high volatility the fixed spreads will be narrower, allowing you to extract more profit.

Dealing on variable spreads also has its benefits since you are often able to enter the market during quiet times at better prices. The downside of course is that should you wish to exit the trade the CFD provider may quote you a wider spread than the spread you were charged when you opened the trade.

Which should you look for? To some extent it depends on your style of trading. If you are active trader, scalper or a day trader, executing frequent transactions during periods of high volatility, then fixed spreads are likely to be the better choice as they are more predictable and not so susceptible to manipulation by the CFD provider. If you are longer-term trader, and particularly if you can arrange to trade during the main active sessions when liquidity is optimal and spreads are narrowest, then a provider offering variable spreads could suit you better.

Whichever type of Forex spread and CFD provider you decide to go for, it is important that you keep an eye on the size of the spreads and the underlying market. Some CFD providers will try to take advantage of Forex CFD traders by offering small spreads when you start trading with low volumes, but widening the spreads when you become more active or place bigger orders. As always it is important for you to choose a CFD broker that is able to provide you the service you need that will fit your trading style as a wrong choice might end up being a costly learning experience.