This article will explain what determines the spread in the forex market and how you can keep it under control and avoid buying or selling when the spread is high.
I will provide you with all the tools to evaluate your broker’s spread, even a MetaTrader4 indicator that you can download for free.
As you undoubtedly know, many brokers in the forex market are real unregulated scam companies. However, many reputable brokers behave correctly with their client traders.
Looking for a low spread broker is undoubtedly a good idea, but choosing a broker based on the spread alone is a grave mistake.
I recommend you visit this Myfxbook page that monitors the spreads of the most popular brokers in the world in real-time.
I recommend that you use this service to monitor spread changes during certain times or important news.
It would help if you considered that generally, the spread will be variable, and therefore, the only way to know the actual spread is to monitor it with the tools that we will see later.
When you have identified a suitable spread for your needs, don’t forget to carry out extensive research on the broker you have chosen before depositing your money.
On the search engines, you can find numerous articles that advise you on spreads and brokers.
Unfortunately, many have affiliate links and may give you advice that is not sincere. You can find a list of reliable brokers at this link, including clients resident in the US.
The spread is your cost of working as a trader; it cannot be underestimated; it is like opening a shop and not minding the too high price of rent or employees’ cost.
Obviously, this article will only examine variable spreads; there are, in fact, some brokers that apply a fixed spread, but this spread is generally higher than the variable one.
What determines the spread in forex
The answer to this question would be obvious, it is the broker who determines the spread in forex; the spread is one way the broker makes money.
In the regulated stock market or futures, the spread rises when buyers do not find the sellers, and therefore to buy, they must move to a price strike that is further away than the minimum tradable value.
I don’t think the same thing applies to the forex market because the broker is the counterparty most of the time, so there really would be no need to increase spreads.
MetaTrader4 is greatly amplified by incorrect behavior bordering on fraud; some spreads make no sense.
The broker will determine its spreads based on many aspects. It will generally try to keep EurUsd as low as possible and will choose increasing spreads for the least traded crosses.
Many traders choose the broker based on the spread, and the brokers have adapted by inserting fixed commissions on variable spreads. You may find a broker who advertises a spread of 0.05 on EurUsd, but it often happens that you are charged a fixed commission on each transaction.
Commissions and spreads
The commission’s presence indeed determines the spread’s amount. The broker will lower the spreads if he can earning commissions.
The commission is the same as the spread, it’s a cost that lowers your earnings, and when commissions are high, tiny spreads are just an illusion.
So I always recommend that you analyze the broker condition about the commissions, which are not hidden anyway, and therefore, it is easy to calculate them.
I have tried several times to make calculations. The spread is mostly aligned between the various brokers and is difficult to compare precisely because of the existence of the commissions. When you agree that it is too low, there are probably commissions.
However, there is a fundamental aspect to keep in mind: commissions are fixed and do not fluctuate like the spread at certain times. Therefore, the presence of commissions reduces the volatility of the spread because it reduces its starting base.
If I have a variable spread of 0.5 pip on average during the day, the spread could double or triple if news comes out at a strange time. Since the starting point is 0.5 pips, the spread will increase significantly in these situations, quickly reaching 2-3 pips.
Now let’s take, for example, a variable spread of 0.2 pip with a commission of 0.3. In this case, the variable part is equal to 0.2. Even if you tripled, it would not exceed one pip even if you include the commission.
Therefore, it should be more advantageous to use a commission to limit the spread’s fluctuations in the forex market. Still, even in this case, it is necessary to monitor the market in real-time.
Why does the spread change on forex?
The spread fluctuates throughout the day, sometimes with extreme and violent movements, which can happen for various reasons. I will explain the most important and predictable.
The broker’s seriousness is the most important thing, and if you do not want to trust blindly, you will have to use tools to control spread changes.
Many aspects can change an instrument’s spread in the forex market; I will list the factors that affect the spread by increasing or decreasing it more than others.
The most important aspect is the traded instrument. As a general rule, remember that a highly traded financial instrument will have a lower and more stable spread due to high liquidity.
Some exotic crosses such as the dollar against the Turkish lira could have very high spreads because it is rarely exchanged.
These crosses will also have a very high swap, and this aspect will also have to be taken into consideration by analyzing the costs of trade.
When you choose a broker, do not just check the spread on EurUsd, which should be the lowest and the most stable. My advice is to monitor all the crosses you intend to trade to have a general idea and understand if it is convenient.
The time of day
The spread will vary according to the time of day. It is always a question of liquidity; the more players are present in the market, the higher the liquidity will be and the low spread.
For example, EurUsd will rarely exceed four pips, while more exotic crosses may exceed 30 pips in the evening or during a news.
On some days of the week, the volatility may be higher or the liquidity lower, and therefore the spread may vary further. Even on Friday evening, just before the forex market closes, spreads will be much higher than usual.
Spread, news and volatility
Does the spread always increase during the news? Generally yes, but it is possible that some news does not cause strong volatility. In fact, it is possible that the news is predicted correctly by analysts and, therefore, does not increase the spread by not causing surprises.
It is still good to keep an eye on the calendar with news divided by importance; one of the most used is the forex factory calendar.
The increase in the spread during the evening hours is repeated over time. Generally, the spread ranges are similar, and therefore, it is possible to predict that the spread will increase and how much.
During the news, however, indicating how much the spread could increase is more complicated. However, it may not increase at all.
Indeed, it is always essential to evaluate the importance of the news and the consensus of analysts. If analysts “guess” the forecast, not much volatility will develop, and the spread will remain unchanged.
One of the news that most widen the spread in the forex market is the FOMC, but even in this case, not all FOMC meetings trigger volatility and high spreads.
The spread and stop-losses
One of the most critical problems following spread increases is closing the position for a stoploss that is hit without the price has moved.
The price rarely undergoes large variations in the evening hours, but a stoploss could be hit due to the spread.
Many think that brokers do this to steal money from clients and hunt for stop-losses, I don’t think so, but I think it’s a bit weird to see spread increases ten times higher than normal fluctuations.
To avoid suffering these annoying stop losses, it is necessary to set up systems that temporarily widen the stoploss when the spread widens. Doing this type of operation during the evening hours is relatively risky, while doing it during the news is certainly not recommended.
During the news, it would be better to have large-stop losses already predicted by the strategy, or you should try to stay flat if the cross is too volatile and you are working with margin.
How to measure the spread in forex
At the bottom of this article, you can download the indicator to measure the spread in real-time on your MetaTrader4 platform.
You will have to place the indicator on the graph. We recommend setting the graph to 1 minute and then observing the spread trend after a few hours.
The ideal thing is to keep the indicator always active on all the crosses that you intend to trade for a whole week to evaluate the impact of times, days of the week, news, etc.
The indicator to analyze spread changes only works in real-time. You will not be able to reference a historical series, nor would it be reliable to do so.
Before writing this article, I inserted the indicator on a EurUsd chart and a GbpJpy chart. The latter will have the highest spread for the reasons we explained to you in the previous paragraphs.
We analyze the trend of the indicator on EurUsd, and we see that the spread was shallow throughout the day until the close of Wall Street. At this point, the spread became much more volatile and fluctuated around four pips. I remind you that it never exceeded half a pip during the day, so during the evening hours, an increase of 800%.
Let’s see how the spread has varied according to the time slot for GbpJpy after it had remained in a narrow range around two pips throughout the day.
After the close of wall street, we see that it has hit 25 pips several times, which is a monster value, given that we are in the absence of news or other market movers.
You don’t need to point out how a change in the spread of this size would have triggered many stop-losses.
How to avoid buying at high spreads
Is there a way to defend against these fluctuations in the spread? It is certainly possible to protect oneself and act accordingly. Meanwhile, we know how to predict when the spread can increase, so we know that we must be cautious at certain times and before certain news.
If we are discretionary traders, we can use scripts to launch orders on the MetaTrader4, incorporating a spread filter. Before sending the order to the market, these scripts check that the spread is not higher than a value defined by the trader.
We can then momentarily widen our stoploss to avoid seeing a losing position closed just because of the spread.
Let’s pretend we are inside a trade on GbpJpy. The cross that we have examined previously and that we have seen have a spread of 25 pips during the evening hours.
The time is approaching when the spread generally rises.
Using our indicator, we know that the spread is often around 25-30 pips in the evening. We can temporarily change our stoploss by increasing it by these 25-30 pips and then bring it back to the initial value after the time. We will do the same thing before the news, although it could be more dangerous as we have seen.
If we are systematic traders and have automated our strategy, we can code and insert filters to spread before any purchase or sale. Furthermore, for the evening hours, we will adapt the stoploss by adding the value of the spread automatically.
As for news, it is better to use an automatic filter that inhibits trading or closes open positions before important news.