Spread trading may take many different forms. The diversity of forex spread trading strategies allows them to be applied in a variety of markets, not just forex trading. Some notable spread trading strategies include:
- Calendar or time spread trading
- Collar spread trading
- Vertical spread trading
Forex spread betting is, however, one of the most popular spread trading strategies used in the currency market. It’s also quite simple to execute.
An Example of a Forex Spread Betting Strategy
Forex spread betting allows the trader to speculate and trade in the currency markets without actually buying or selling the underlying currency pairs.
Usually, when bet on forex spreads, you stake a certain amount of money, say $1 per pip. (Some providers may even offer fractional pip pricing, which makes the spread even tighter and more accurate.)
Let’s suppose that after staking $1 per pip, the currency pair that we are trading moves from 1.2345 to 1.2347. That’s a 7-pip rise, which will make us a cool $7. The net amount we make from this trade, however, will be the $7 we made multiplied by the size of our trade minus the transaction fees. It’s also worth mentioning that if the market had gone down by 7 pips, we’d have incurred $7 loss per pip.
Leverage in Forex Spread Trading
Currencies won’t typically move 7 pips in one day, like in our example above. However, you can still make decent money by taking advantage of the day-to-day fluctuations.
Movements in the forex markets in most cases are minuscule. Consequently, if, for example, the market moves in favor of your trade, but you only have $100 in the market, your gains might not go beyond more just a few cents. Obviously, there’s nothing to be excited about making a measly few cents per trade.
You’ll, therefore, need to invest handsomely to earn a decent amount each time you trade in the currency market. What if you can’t raise enough money to place a sizeable bet on the market?
Not every trader is able to raise tens or hundreds or thousands of dollars for forex trading purposes. Hence, most brokers offer their clients leverage. If your broker offers you a 100:1 leverage ratio (some brokers may even go as high as 400:1) and you invest $100 upfront, you may then take positions of up to $10,000.
The Cost of Forex Spread Trading
The cost of placing a forex spread trade depends on several factors, but mostly, the cost will be determined by 1) your financial provider/broker and 2) the duration you keep your trade position open.
Remember also that the forex is highly responsive to other events happening all over the world, which makes it both highly liquid and volatile. Therefore, every spread trader needs to have at least a right level of understanding about how currency interest rates, fundamentals as well as the technical aspects affect the outcome of their trades.
Beware of Widening Spreads
Simply, think of forex spread as the cost of taking a position in the currency market.
Therefore, a widespread means that it’ll cost you more to trade. On the other hand, thinner spreads lower your trading cost, which, at the close of your trade, makes your profits larger and your losses smaller.
Thus, dealing with brokers who offer the tightest forex spreads is key to upholding your success as a currency trader.
Note: if you want to keep your forex trading costs low, go for a broker who offers competitive quotes with thin spreads, minimal slippage, no commission, no markups, and instant execution.
Factors That Lead to Widening Spreads
The general rule is that spreads widen when the market volatility is high. (Note also that the risk/reward ratio is also high during highly volatile events.) All the same forex spread tends to be wide if:
- Volatility is high- negative economic statistics mostly precipitates volatility
- There’s a breaking of adverse financial news events
- Illiquidity occurs
- You are trading in emerging markets
- You are trading at an unfavorable time of day, such as when most trading sessions are either closed or at their lowest.
Indeed, many forex traders have met financial doom while trading high spread currency pairs during times of volatility, especially if their positions were leveraged.
Nevertheless, as the forex market fluctuates, widened spreads may revert in a matter of minutes or days. However, sometimes that doesn’t happen, and the spread keeps getting bigger. Therefore, if spreads keep on widening while you are actively trading, you should consider triggering stop loss to help minimize your trading cost and even prevent you from incurring massive losses.
Benefits of Forex Spread Trading
- The spread of the currency pair
- The direction of your trade
- The size of your trade
The profitability potential of forex spread trading is also significantly high, especially when trading leveraged low spread currency pairs.
Forex spreading trading strategies are some of the low-risk currency trading strategies. It also easy to hedge your positions using these strategies.
Conclusion
Forex spread trading is an easy and flexible way of making money in the currency markets. But beware; just like other forex trading strategies, it isn’t 100% foolproof. Therefore, take your time to consider all variables before entering the market and if possible, complement your strategy with other strategies that might help you offset any losses you incur.