With liquidity of over $ 4 trillion in notional value per day, the global forex market allows traders to enter and exit with little upfront cost. The majority of the exchanges that take place in the forex market are over-the-counter, where an investor takes the prices of a broker or dealer to enter and exit forex positions. The majority of people who participate in the over-the-counter forex market are used to the spreads of the currency pairs they wish to trade.
When an investor trades in the forex market, he should be concerned with two associated prices which are the bid which is the price at which you sell and the ask which is the price which you have to pay. The difference between the two is what a trader is used to as a spread. The spread is the commission the broker pockets and what the trader pays for the cost of doing business. In futures trading in the currency market, a trader will pay not only this spread, but also a commission to their futures broker.
If a trader is unaware of the supply gap, he may end up choosing a trading strategy that will fail because he does not incorporate that cost into his strategy. When a trader places a trade for example and there is a spread of 3 pips associated with this trade, there will be a spread of 6 pips for this trade. If your strategy is to quickly enter and exit the market trying to generate 5 pips per trade, in this example you will need to generate 11 pips to be successful.
Let’s take a look at an example trade and the challenge a trader can potentially face. Let’s say each pip is worth $ 1.00. 3 pips in and 3 pips out add up to $ 6.00 only in the price of the spread for a single trade. What a trader needs to understand is that in order for him / her to make money, the trade has to move 6 pips in his / her own favor to break even and 7 pips to make money.
The good news is that if you can find a broker whose typical spreads on major pairs (EUR / USD, GBP / USD, USD / JPY etc.) are closer to 1 or 2 pips, you can significantly reduce your costs of. transaction. So, one of the most important aspects of Forex trading and to give yourself a chance to fight for continuous profitable trades is to find brokers who offer reasonable small spreads.
A trader should always keep in mind that trading is a business and, as with any business, there are associated transaction costs (in this case, spreads) associated with doing business. Therefore, anything that the trader can do to reduce these costs will increase their chances of improving their bottom line and potentially a successful trade.
The spread can be seen as a hidden cost, as its magnitude is not apparent during a trading session for the trader. One of the easiest ways for a trader to avoid these hidden costs is to find a reliable, solid broker who offers reasonable prices on spreads. The easiest way to do this is to shop around for prices. When working with a broker, find out if the spreads are fixed or variable. Again, by doing this you will be giving yourself a head start on a potentially winning trade.