One of the most important factors to consider when you are choosing a trading broker is the spread costs that will deducted from your account each time a trade is placed. Since this is literally something you will have to consider each time you enter into a new position, special attention must be enacted in order to make sure that you are getting the best deal (and the lowest costs) in each case.
There are other factors to consider (visit Trading Education section), however, as all spread arrangements are not the same. Specifically, you will encounter some brokers that will offer “fixed” spreads whereas other brokers will offer “variable” spreads. So, since this is so important, what is the difference between the two broker spread arrangements?
Fixed Spreads Versus Variable Spreads
When dealing with spread options, brokers will generally offer you two choices: Fixed Spreads and Variable Spreads. Fixed spreads are constant and will never change. Essentially what this means is that if you are quoted a 3 point spread in the EUR/USD, you will always be able to trade with that spread costs, no matter what time of day, not matter how volatile or illiquid the market becomes. This can be vital for trading in many situations, especially short term trading strategies such as news trading or intra-day swing trading methods.
Fixed spreads offer traders some peace of mind, as there is a guaranteed assurance that spread costs will not widen and become substantial enough to erode your previous gains and deplete your trading account. Depending on the currency pair you are trading, the differences can be substantial.
While there might be less of a difference in trading assets such as the EUR/USD or the S&P 500 (which are very commonly traded and have high liquidity levels), more exotic assets (such as the GBP/JPY or small-cap stock shares) can see extreme changes in spread costs if market volatility increases. Since there are many cases where volatility can increase without much warning, traders can do themselves a major service my requiring fixed spreads so that trading costs are always constant and predictable.
Variable spreads can also be offered by brokers. In these cases, your broker will constantly change your spread costs based on market conditions. When market activity is quiet and stable, spread costs will be lower. But when this changes (for example, during times of a major news event or economic release) these spread costs will widen, making each trade more expensive to execute. These differences can make it difficult to plan your trades, because your profit and loss ratios will always be changing.
Benefits of Fixed Spreads in Long and Short Term Trading
Since market conditions can change without prior warning, fixed spreads will be very important for traders that have specific and exact trading plans. This type of planning generally tends to be seen in technical chart trades (more often than in fundamentally based trades) but there are benefits to fixed spreads for all types of trading strategies. Whether your trades tend to be long term or short term in nature, there will not be a risk of encountering excessively high trading costs when brokers upwardly adjust your spread costs.
In addition to this, brokers that offer fixed spreads will usually offer guaranteed trade execution as well, and this is important for removing “slippage.” Slippage is seen when trades are executed, not at the level you ordered, but at the level that was available from your broker. This is another example of how trading costs can be drastically increased without broker guarantees. What you should always be looking for as a trader is to reduce your overall costs so that you can maximize your gains over the longer term time frame.
In conclusion, you should always remember that when you are looking for a new broker, you will generally be given the option of choosing fixed spreads or variable spreads. There is a high level of importance in making the best selection in this instance, as this is something that will have a large impact on all of your trades down the road. The importance of choosing fixed spreads come mostly from the added security and predictability that comes with fixed spreads, so always be sure to keep this in mind before signing any new broker agreements.