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Every Forex trader must contend with spreads. It allows the market to function and it’s the cost of doing business in the world’s most liquid financial markets.
However, for some traders, the same spreads have a larger effect on their trading than others. This is particularly true for scalpers because scalpers generally trade more, and the size of the spreads is a higher proportion of their profit targets.
In this lesson we take a deep dive into the major factors that effect spreads from broker selection, the Forex pair you choose to trade, the time of day you choose to trade, and news announcements.
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Spreads have a much larger effect on Scalpers than on longer-term traders.
If your profit target for a trade is 50 pips, and the spread increases from 1 pip to 2 pips, it won’t make a huge difference to your profitability. But if you are a Scalper with a 10-pip profit target, your profit is suddenly reduced by a whopping ten percent!
If you are scalping the markets for a small number of pips on each trade, you should focus on having the tightest spreads possible.
What factors affect your spreads?
One. Broker selection. Some brokers just offer lower spreads than others. This could be because of their access to liquidity in the markets or it could be just their own business model. But whatever their reasons, spreads will vary between brokers. Just like buying a car, you need to shop around.
Two. The Forex pair you choose to trade will impact the spread. Major pairs, in other words pairs that include the US Dollar, normally have lower spreads than pairs that do not include the US Dollar. For example, EUR/USD will usually have a lower spread than GBP/JPY at any given time.
Three. Time of day. During the week, the Forex market is open twenty-four hours a day, but there are times of day that usually offer higher volume and liquidity than other times. Higher volume usually means lower spreads. The most[U1] liquid session time is the US Open starting at 8am Eastern Time. The next most liquid session time is the London Open which begins at 8am UK time (or 3am Eastern Time) These times are great for Scalpers. If, on the other hand, it is 9pm Eastern Time or 2am UK time, the spreads will often widen because the main institutions that provide liquidity are offline. There are brokers that charge a fixed spread regardless of time, but you will almost certainly have to pay a higher spread most of the time compared to variable spread brokers to compensate.
Four. Upcoming news announcements. Brokers that have a variable spread will increase the spreads prior to a big news announcement, for example, an interest rate or employment number announcement. This helps the brokers offset the risk from the expected volatility. Anyway, you typically would not want to be opening a trade immediately prior to a news announcement because of the very high risk.
Don’t forget that slippage can happen, especially if you trade outside liquid session times or just before news announcements. Slippage means getting a worse fill for your order than you expected. For example, if your stop loss on a long trade is at one seventeen fifty, but you get filled at one seventeen sixty, you lose 10 pips more than anticipated.
If you want to scalp the markets, try to keep your spreads tight and your slippage to a minimum by choosing a broker that can deliver this. Trade the major pairs. Trade at the right times of the day. And don’t trade just before major news announcements.
[U1]The New York / London overlap has the highest overall liquidity in the Forex market
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