Trading expenses play a major role when it comes to making profits in the long run. For instance, traders dealing with prop firms should pay close attention to their costs when trading because even such a small detail as the spread can influence their ability to pass evaluation phases and work with an instant funding account effectively. It is crucial to know about the distinction between fixed and variable spreads.
In this article, we will discuss fixed and variable spreads, their advantages and disadvantages, and what option is better for prop traders.
What Is Spread in Forex Trading?
It refers to the gap between the buy and sell price of a currency pair. In essence, it is a broker's fee for trades.
Consider the following example:
- EUR/USD Buying Price = 1.1052
- EUR/USD Selling Price = 1.1050
The difference is 2 pips, that means the spread is 2 pips.
Whenever you initiate a trade in forex, you begin with an immediate loss corresponding to the spread fee.
Another question many newcomers have concerns how to find spread in forex. It can be calculated as follows:
- text{Spread} = text{Sell Price} – text{Buy Price}
Thus, in case if EUR/USD Sell Price is 1.1052 and Buy Price is 1.1050:
- 1.1052 – 1.1050 = 0.0002 = 2 text{pips}
Learning how to calculate spread in forex allows traders to estimate their expenses on transactions.
What Is Fixed Spread?
Fixed spread does not depend on market circumstances; it is the same whether the market is quiet or very turbulent.
Example:
- Fixed spread EUR/USD = 2 pips
- Fixed spread GBP/USD = 3 pips
There are no fluctuations in spreads even if market conditions are normal.
Advantages of Fixed Spread
1. Predictability
With fixed spreads, traders can be sure of the exact amount they will pay per transaction, which simplifies risk management.
It is beneficial for professional traders to know their costs for evaluation accounts that have tight drawdown regulations.
2. Best for Novices
Fixed spread is advantageous for novice traders because of market turbulence.
It is beneficial for traders who use an instant money account since consistency is more important than high returns.
3. Helps When Market is Illiquid
The fixed spread would safeguard the trader from sudden spread increases that occur when liquidity is low in the market.
E.g.
- During opening time of the market
- During closing time of the market
- During holidays
Disadvantages of Fixed Spreads
1. Higher Cost Structure
Fixed spread would be higher compared to average spread of variable spreads when market is functioning normally.
E.g.
- Fixed spread = 2 pips
- Average spread of variable spread = 0.8 pips
2. Not So Beneficial for Scalping Positions
Scalpers need small spreads to generate quick profit margins.
Advantages of Variable Spreads
1. Reduced Trading Cost
The spread in variable mode is lower during busy times such as:
- London Session
- New York Session
This will help the trader reduce his cost of trading.
To an active trader, it becomes extremely important to understand the calculation of spread in forex since it keeps changing.
2. Favorable for Scalpers/Day Traders
It is very favorable for scalpers since scalping focuses on small profits.
It provides:
- Shorter time period for breakeven
- Higher ratio between the reward and risk
- More profitable trades
Therefore, many professionals in prop trading choose variable spread.
3. True Market Pricing
Variable spread gives true market pricing where traders are provided institutional level pricing.
It is common in prop trading systems and instant financing system.
Drawbacks of Variable Spreads
1. Expansion of the Spread during News
The major problem associated with variable spreads is their sudden expansion due to volatility.
For instance:
- Non-Farm Payroll statistics
- CPI data
- Interest rate changes
An average spread of 1 pip may suddenly become a spread of 10 pips.
It will cause stop loss orders to work unintentionally.
2. Difficulties with Risk Management
As spreads vary, it becomes difficult for traders to determine the exact cost of trading.
It poses problems for proprietary traders who trade on a strict drawdown basis.
What Type of Spread Is Best for Prop Firm Traders?
It all boils down to individual styles, experience, and trading approach.
Why Fixed Spread Is Best for:
Beginners
Beginners find it easier to trade with stable costs.
Swing Traders
Because swing traders hold their trades for longer periods, small differences between spreads are not an issue.
Traders Who Avoid News Events
Trading with fixed spreads is easier because of the added stability.
Why Variable Spread Is Best for:
Scalpers
To get maximum benefit from scalping, traders need tight spreads.
Experienced Traders
Experienced traders are familiar with market volatility.
High Frequency Traders
High-frequency traders do well when the spreads are low.
Valuable Insights for Prop Firm Traders
1. Don’t Trade When There Are News That Could Create High-Impact Situations
Spreads could be variable when there are high impact situations, such as economic events.
Many prop traders refrain from trading:
- CPI announcements
- FOMC announcements
- NFP releases
2. Consider Checking Your Broker’s Conditions
Every broker offers different spreads, and so do different prop firms.
Before deciding which broker or prop firm you should trade with, you need to evaluate:
- Average spreads
- Commissions
- Slippage conditions
- Speed of execution
Just because the spread is low doesn’t mean that everything is fine.
3. Know What You’re Paying Altogether
Most traders focus solely on spreads while disregarding commissions.
Here’s an example:
- Raw spread = 0.2 pips
- Commission = $7 per lot
The actual cost would be more expensive compared to a fixed spread account.
Fixed and Variable Spreads: A Side-by-Side Comparison
Attribute
Fixed Spread
Variable Spread
Price Stability
High
Low
Average Price
More expensive
Less expensive
Good for Novices
Yes
Moderately good
Ideal for Scalpers
Not suitable
Suitable
Impact on News Volatility
Low
High
Predictability
Excellent
Moderate
Institutional Rates
Spread Choice Influence on Instant Funding Traders
Instant funding account traders should be careful about risk management as fast funding accounts normally come with rigid terms.
Spread widening will:
- Activate stop-loss orders
- Raise the drawdown
- Violate the trading account
Thus, depending on personality and strategy:
- Cautious traders may opt for fixed spreads
- Risk-loving traders may opt for floating spreads
- It all depends on the individual trader’s preference.
Conclusion
It is worth mentioning that both types of spreads have their own pros and cons. There is no optimal choice for everyone.
Fixed spreads can be beneficial with their consistency, predictable cost, and easier risk management. Variable spreads can provide reduced costs and better conditions for active traders.
In the case of prop firm traders, it is crucial to choose a proper type of spread taking into account:
- Type of trading
- Risk appetite
- Market environment
- Account policy
Typically, beginners and swing traders opt for fixed spreads, whereas skilled scalpers and day traders go for variable spreads.
However, what matters most of all, is that each trader should know how to calculate forex spread.