The foreign exchange market is rapidly becoming the most popular markets for trading.
Not merely are the expert traders looking to forex trading to increase their trading returns, but the majority of new, individual investors are now able to trade the foreign exchange market — just as they do stocks and futures.
More and more individuals are seeing Forex not just as a new way to diversify their portfolio, but are also finding that it really is becoming the absolute most profitable component of these investments.
And that’s because of the several benefits Forex offers over other markets like stocks or commodities. Here is what you certainly will typically see marketed about Forex:
— Unparallelled liquidity. It will be the largest financial market in the world by far. Almost $2 trillion being traded daily!
— Excellent leverage potential. Individual investors gain access to leverage of 100:1 and even 200:1
— No Commissions (more about this down the road)
— Low trading costs.
And yes, the foreign exchange market really does offer all of these advantages.
Nevertheless the last two points above talk about costs, and that’s what we’d prefer to concentrate on in this specific article.
Like any trading, there are costs involved, and, while these may be much lower than they had previously been, it’s important to understand what those are.
Let’s start by taking a look at stock trading, a thing that the majority of us investors are pretty acquainted with.
When stock trading, most investors will have a trading account with a broker somewhere and will have investment funds deposited for the reason that account.
The broker will then execute the trades with respect to the account holder, and of course, in substitution for providing that service, the broker may wish to be compensated.
With stocks, typically, the broker will earn a commission for executing the trade. They will charge either a set dollar amount per trade, or a buck amount per share, or (most frequently) a scaled commission based on what size your trade is.
And, they’re going to charge it on both sides associated with the transaction. That is to say, once you buy the stock you receive charged commission, after which when you sell that same stock you receive charged another commission.
With Forex trading, the brokers constantly advertise “no commission”. And, of course that’s true — except for a few brokers, that do charge a commission much like stocks.
But additionally, of course, the brokers are not performing their trading services 100% free. They too earn money.
How they accomplish that is through charging the investor a “spread”. To put it simply, the spread may be the distinction between the bid price as well as the ask price when it comes to currency being traded.
The broker will add this spread onto the buying price of the trade and ensure that is stays as their fee for trading.
So, while it isn’t a commission per se, it behaves in practically the same way. It is just a little more hidden.
The great news though is that typically this spread is just charged on a single region of the transaction. In other words, you do not pay the spread when you buy AND then again once you sell. It is usually only charged regarding the “buy” region of the trades.
So that the spread in fact is much of your cost of trading the Forex and you should pay attention to the main points of what the different brokers offer.
The spreads offered can vary pretty dramatically from broker to broker. And even though it may not appear to be much of a significant difference to be trading with a 5 pip spread vs a 4 pip spread, it really can truly add up very quickly when you multiply it out by what number of trades you make and how much money you’re trading. Think about it, 4 pips vs 5 pips is a significant difference of 25% on your own trading costs.
The other thing to identify is the fact that spreads can differ according to what currencies you are trading and what sort of account you open.
Most brokers provides you with different spreads for different currencies. The most famous currency pairs such as the EURUSD or GBPUSD will typically have the best spreads, while currencies that have less demand will likely be traded with higher spreads.
Be sure to think about what currencies you are almost certainly to be trading and discover exactly what your spreads will likely to be for all those currencies.
Also, some brokers will offer you different spreads for several types of accounts. A mini account, for example can be subject to higher spreads than a complete contract account.
Last but not least, since the spreads really are the essential difference between bid prices and get prices as decided by the free market, it’s important to notice that they may not be “guaranteed”. Most brokers will say to you that there may be times during periods of low demand, or very active trading once the spreads widen and you’ll be charged that wider spread.
These do tend to be rarer situations due to the fact currency markets in fact is so large and demand and provide are often quite predictable, nevertheless they do occur, especially with some regarding the lesser traded currencies. So it is crucial that you be aware of that.
To sum up then, when trading Forex, understand that the “spread” is truly your most critical consideration for trading costs.
Spreads may differ significantly between brokers, account types and currencies traded. And small differences in the spread can definitely total up to 1000s of dollars in trading costs over even just a couple of months.
So be sure to determine what currencies you will be trading, how frequently, plus in what type of account and employ those factors to greatly help decide which broker will offer you the best trading costs.