Which is Better? Fixed Spread or Floating Spread

For traders, even small details like spreads can make a massive difference. There are two types of spreads: fixed and floating, each with distinct characteristics that can significantly impact your portfolio's profit and loss if not properly understood. Moreover, traders who grasp the principles of how spreads work can better leverage opportunities to profit from the market. Today, we'll discuss fixed and floating spreads, their key features, advantages, and disadvantages, to help you choose the most suitable spread type for your trading strategy.

What is a Fixed Spread?

A fixed spread is a type of trading cost where the difference between the buy and sell price remains constant, regardless of market volatility. This allows traders to anticipate expenses in advance. Generally, the spread is around 3 pips or more, depending on the currency pair and the broker's policies. The main advantage of fixed spreads is their consistency and predictability, although they may sometimes be higher than variable spreads during periods of high market liquidity. Nevertheless, for those seeking simplicity in cost calculation, fixed spreads remain a viable option, especially for short-term traders or those using strategies that require precise entry and exit point calculations.

Advantages and Disadvantages of Fixed Spreads

Advantages of Fixed Spreads 

• Certainty in cost calculation
  Fixed spreads allow traders to calculate trading costs accurately, as the spread doesn't change with market conditions. This facilitates easier strategy planning and risk management.

• Suitable for stability-seeking traders
  Traders who prefer not to deal with spread volatility favour this model, particularly novice traders who want certainty in calculating costs and profits.

• No concerns about spread spikes during important news
  During significant economic announcements, fixed spreads do not suddenly increase, allowing traders to operate during these times without worrying about escalating costs.

Disadvantages of Fixed Spreads

• Higher spreads in normal conditions
  Generally, fixed spreads are often higher than variable spreads in normal market conditions, as brokers must account for market volatility risk. This means traders may pay higher spreads during periods of high market liquidity.

• Limitations on news trading
  Some brokers may impose restrictions on trading during important news announcements to mitigate market volatility risks. This could cause traders to miss potential profit opportunities during these periods.

• Higher chance of requotes
  During high market volatility, requotes may occur more frequently as brokers adjust prices to align with market conditions. This might prevent traders from getting their desired price when opening or closing orders.

Fixed Spreads are Suitable for Short-term Trading

Fixed spreads are particularly well-suited for short-term trading because they allow traders to calculate transaction costs more accurately, regardless of market volatility. The consistency of the spread enables traders to plan their trades more easily and know in advance the fees they'll pay for each trade. Trading with fixed spreads also helps reduce the risk from sudden price changes, allowing traders to enter and exit the market more quickly without worrying about sudden spread increases when they need to close their positions.

Fixed Spreads are Suitable for News Trading 

For traders who fancy news trading, fixed spreads are a suitable option. When major news is announced, the market often experiences intense volatility in a short period. If trading with an account that has floating spreads, the spread may widen significantly during periods of high volatility, resulting in higher trading costs. However, with fixed spreads, regardless of market volatility, the spread remains constant, allowing for better cost control. Additionally, it helps to predict profit and loss more accurately, as there's no need to worry about how much the spread will widen and eat into profits. Fixed spreads are thus a choice that helps news traders manage risk more easily and potentially increase their profit opportunities.

Fixed Spreads are Suitable for Automated Trading Systems

Automated trading systems have become a popular choice among modern traders, as they enable swift and precise trading while reducing emotional decision-making. However, one crucial factor to consider when using automated trading systems is the spread. If spreads are highly volatile, it may lead to system losses. Therefore, opting for services with fixed spreads allows for clear calculation of trading costs and reduces the risk from spread volatility. This ensures that our automated trading system can operate without concerns about losses due to spread fluctuations.

What is a Floating Spread?

A floating spread is the difference between the bid and ask prices in Forex trading that constantly changes, reflecting market conditions. This type of spread effectively mirrors market liquidity and volatility. When the market is highly volatile, spreads tend to widen, and conversely, when the market is quiet, spreads narrow. Moreover, spreads vary depending on currency pairs, market differences, and individual broker policies. Understanding floating spreads helps traders adjust their strategies to market conditions and choose brokers that suit their trading style.

Advantages and Disadvantages of Floating Spreads 

Floating spreads have the notable advantage of adjusting continuously to market liquidity and volatility, thus reflecting actual market conditions better than fixed spreads. On average, floating spreads are often lower than fixed spreads, especially during active market periods with minimal movement, where floating spreads are noticeably narrower than fixed ones.

However, the drawback is that it becomes more challenging to calculate trading costs in advance. During periods of market volatility or when prices deviate from expectations, especially when significant news breaks or the market is turbulent, spreads may widen considerably. This makes floating spreads less suitable for certain automated trading systems that rely on spread consistency.

Short-term Trading Strategies

We can take advantage of narrow spreads during high liquidity market periods to reduce costs. This method increases the chances of profiting from small price movements, especially during main market opening hours such as European or American mornings. Alternatively, scalping is a trading technique that focuses on making profits from minor price movements in short time frames. Traders using this method open and close multiple trades in a single day, often using short time frame charts like 1-minute or 5-minute intervals. This approach requires high accuracy and good risk management.

Market Condition Strategies

Traders can benefit from spread changes during important economic announcements in several ways. Before significant news releases, spreads typically widen due to market uncertainty. Traders may choose to enter the market before the spread widens significantly. After the announcement, spreads often narrow again as the market stabilises. This could be a good opportunity to enter the market at lower costs.

Strategies for Experienced Traders

Certainly, to utilise floating spreads effectively, traders need experience, as it's a complex trading method requiring high expertise. It's suitable for those with deep market knowledge who can adapt quickly to changing market conditions. One must adjust rapidly, analyse the market thoroughly, and maintain good emotional control.

Recap

Lastly, for traders interested in leveraging floating spreads using market condition strategies, it's crucial to understand market dynamics and have the ability to adapt swiftly. Traders should closely monitor the economic calendar and be prepared for constant market condition changes. Additionally, good risk management is essential, especially during highly volatile periods, to prevent potential losses from unexpected price movements.

Note: This article is for informational purposes only and does not constitute investment advice.