A spread is a difference between two rates or prices of an asset, which is also the factor that states how much profit or loss a trader would make. For example, when a forex trader buys an asset at 2.110 and the current market rate is 2.120. The spread here is 0.10 points. Though it is not always that simple, and there are many types of spreads as well.
Fixed spreads are the difference between Ask and Bid prices, set by the broker and remains the same even though the prices are changing because of general market fluctuations and volatility or any market conditions at any given time. Floating spreads are the difference between Ask and Bid prices, and they are changing over time, depending on market volatility and available liquidity.
The main difference between fixed and floating spreads is how spread values are formed because a fixed spread is a simple difference between an ask and a bid price and the floating spread continuously changes values between the bid and ask rates.
Let’s discuss it more in detail.
A fixed spread often aids traders in knowing the most important thing, their cost, without any consideration or impact of the market. It is the difference between the ask and the bid rate. It is like you buying goods from a wholesale market player and selling it at a high price. A lot of traders also maintain the spread and make changes as per the volatility.
For a highly volatile market, the spread would change for your every trade. There are various formulas to count this spread, but it is essential to learn it as a trader.
A fixed spread helps you to know the spread cost even before you trade or plan your strategy. This benefits traders in terms of transparency and knowing the cost, and calculating the profit potentials.
What are the Things that Affect Spreads?
Fixed spreads do not change much, but it depends on the instruments you are trading. At the same time, a variable or floating spread can tell the liquidity portion of the market.
The two main factors affecting the spreads are as follows.
- The demand and supply of a financial asset
- The underlying asset and its trading practices
Fixed Spread Vs. Floating Spread
The main difference between fixed and variable (floating) spreads is that a fixed spread remains unchanged even during high volatility while a variable spread (floating spread) fluctuates in a range. Variable spreads can drastically increase during trading news and high volatility.
When it comes to the forex market, the spreads are of two types – Fixed and Floating/Variable.
As stated earlier, the floating spread keeps changing between the ask and bid prices of an asset. For example, if you buy a currency pair, things like its demand and supply would impact its rate. So, the price you pay to cover such a cost is called a spread.
Generally, brokers provide tight spreads, which are also called variable spreads. Though many times, what you pay is too different from what you were offered initially. Spreads act tight during the active trading sessions and high liquidity cases. You can take examples of the London-New York overlap here.
Floating spreads are also referred to as a “completely market phenomenon.”
Why is a Fixed spread better than a Floating spread?
Fixed spreads are simple and are set by the broker. But unlike floating spreads, they do not change due to market volatility or changes. A trader pays here what he was offered. Floating spreads may look attractive, but in the end, fixed spreads save money in the long run.
A fixed spread is better than a floating spread because of transparency, low cost, the better response on trading news, the wall against volatility, and it is better for short time trading.
Costs for fixed spreads are known and transparent. You already know what you are supposed to pay before you take the trade. Also, volume, interbank liquidity, etc., would not impact the spread. So, nothing can manipulate the fixed spread, and thus it provides great transparency to traders.
2. Low Cost
Opting for fixed spreads saves money as it lowers your cost of trading. There are no surprise elements here, and you get the charges beforehand. Having such control will give you an upper hand over your trades and trading strategies.
3. News Trading Becomes Easy
In the forex market, volatility tends to be high, and many things affect that, including news events. A floating spread is definitely beneficial for calm market conditions, but a fixed spread is highly advantageous for volatile markets. It remains fixed and reduces the risk of larger spreads. Eventually, it gives more trading opprtunit8ies.
4. A Wall Against Volatility
As stated earlier, volatility is a part of forex trading, and it can make the whole trading process and floating cost calculation confusing. But a fixed spread can help here, especially if you are new in this realm. It eliminates the uncertainty and eases the process.
5. Better for Short Term Trading
If you are a short-term forex trader, then you may be taking many traders in a short span of time. Calculating variable spreads can be time-consuming in such cases, thus fixed spreads can come in handy. The high level of transparency and easy method of calculation proves beneficial for short-term traders.
The Bottom Line
The bottom line here is that both the spreads have their own advantages and disadvantages, and depending upon your trading strategy and preferences, you should choose a spread that is suitable to you. You can gain more information about the forex market through online materials and research papers, which is essential to make a living in this arena.
So, educate yourself, keep yourself updated, trader cautiously, and learn from your mistakes. After all, slow and steady wins the race. All the best!