Fighting Against Forex Spreads

Fighting Against Forex Spreads

Unlike other markets, such as the stock market, where commissions are flat rate and fixed, commissions in the foreign exchange market are subtracted via the spread only, and they have a huge effect on traders, especially shorter term traders.  Forex spreads can make or break your portfolio, and conducting the right forex broker spread comparison is critical to staying in the black.

Forex Spreads

Before settling on a broker, it is important to conduct a complete forex broker spread comparison.  Some brokers offer lower forex spreads on popularly traded pairs like the EUR/USD or the GBP/USD, but higher forex spreads on exotics like the USD/NZD.  Choosing a foreign exchange broker that offers forex spreads that are workable with your trading habits and strategy is very important, as it can make the difference between winning and losing trades.

Spreads in the Short term

Longer term trading strategies are more resilient to forex spreads because the cost of the spread is diluted over greater pip profits.  Day trading the EUR/USD pair may cost you 2 pips on a 10 pip take profit, for a 20% cost of profit with each winner.  In the longer term with a 100 pip take profit, a trader would give up only 2% of the trade to commissions.  The difference here is dramatic, and making the right forex broker spread comparison does indeed frequently make the difference between winners and losers.

A proper forex spread trading strategy should include the cost of the forex spreads into the win and loss ratio, as well as profitability.  Let's assume that you're a scalper, and you seek to make 5 pips with each trade.  Assuming a spread of 2 pips, you would need a currency to run 7 pips in your direction to make a profit.  To lose with a 5 pip stop loss, however, the same currency pair need fall only 3 pips after completing the trade.  That is a very dangerous trading strategy, since a much larger (233% larger!) move needs be made in the market to create a winner compared to a loser.

This discrepancy can be offset in a variety of ways, most easily by either expanding your take profit and stop loss equally or by offsetting the spread with a bigger stop loss and the same size take profit.  If you find that your trades win 80% of the time with a take profit at 5 pips and a stop loss at 10 pips, then you're very much profitable, winning 20 pips for every 10 you lose.   However, keep in mind that it is usually not so easy to change the stop loss and take profit targets without affecting profitability.

The bottom line is that calculating commissions is an absolute critical part to developing a winning forex spread trading strategy that will keep you in the black. 
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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