“The choice between fixed and variable spreads depends largely on your trading strategy and risk tolerance.”

When trading in the forex market, you will find that spreads make up a large part of your trading costs. Did you just ask yourself what spreads are? Ok, let’s rewind a little bit. The spread is the difference between the bid price (the price at which your broker is willing to buy a currency pair from you) and the ask price (the price at which your broker is willing to sell the currency pair to you). It essentially represents the cost of making a trade.

There are two primary types of spreads that forex brokers offer: fixed and variable (or floating) spreads. Each comes with its own set of advantages and disadvantages. In this article, we will cover the difference between them, and go through the pros and cons of each.

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Fixed Spreads

A fixed spread, as the name suggests, remains constant regardless of market conditions. The broker sets the spread at a specific value, and it does not fluctuate based on market volatility or liquidity. This type of spread is typically offered by brokers who operate as market makers. They create their own market for traders and often execute trades internally rather than passing them on to the external market.

Advantages of Fixed Spreads:

  1. Predictability: Because the spread does not change, traders know exactly what cost they will incur when opening or closing a position. This predictability can be particularly useful for traders who are engaged in high-frequency trading.
  2. Stability in Volatile Markets: During periods of high market volatility, fixed spreads can be an advantage because they remain stable even when market spreads widen. This can protect traders from unexpected increases in trading costs during major economic announcements or events.

Disadvantages of Fixed Spreads:

  1. Requotes: To maintain fixed spreads, brokers can issue requotes during volatile market conditions. A requote occurs when the broker cannot execute a trade at the requested price and offers a new price instead. This can lead to missed trading opportunities, and is often a source of frustration for traders who can’t execute trades at the price they see.
  2. Slippages: A slippage occurs when a broker executes a trade at a different price than the expected one. This is because the broker is not able to maintain fixed spreads during volatile market conditions. Slippages are also a cause of frustration for traders, especially those who rely on precision and have specific entry or exit points in their strategy.
  3. Wider Spreads in Stable Markets: Fixed spreads are often set slightly higher than the average variable spread. In stable market conditions, traders might find that they are paying more compared to variable spreads, which could lead to higher overall trading costs.

Variable Spreads

Variable spreads, also known as floating spreads, fluctuate depending on the market conditions, such as volatility, liquidity, and overall demand. These spreads are typically lower during times of high liquidity (e.g., when major trading sessions overlap). Variable spreads are generally offered by brokers who provide direct market access, passing trades directly to the interbank market without intervention.

Advantages of Variable Spreads:

  1. Lower Costs in Stable Markets: In times of market stability and high liquidity, variable spreads can be significantly lower than fixed spreads, reducing the cost of trading for the trader.
  2. No Requotes or Slippages: Because the spread adjusts in real-time based on market conditions, traders do not experience requotes or slippages. This can lead to smoother trading execution, especially in volatile markets.

Disadvantages of Variable Spreads:

  1. Uncertainty: The main drawback of variable spreads is their unpredictability. Traders might open a position with a low spread, only to see it widen due to sudden market changes in times of high volatility.
  2. Higher Costs in Volatile Markets: During times of extreme market volatility, such as major news events or economic releases, variable spreads can widen, leading to higher trading costs.

Which Spread Type Is Right for You?

Let’s cut to the chase. The choice between fixed and variable spreads depends largely on your trading strategy and risk tolerance. If you prefer predictability and trade in a volatile market, fixed spreads may be suitable. However, you must also watch out for the possibility of requotes and slippages. On the other hand, if you are looking to minimise trading costs in stable markets, variable spreads would be the better option. They would also allow you to avoid requotes and slippages.

Are you wondering which spread type we offer? At XM, despite being a market maker broker, we offer our traders variable spreads. In this way, we eliminate the possibility of requotes and slippages, and keep our execution free from interruptions. Variable spreads also allow us to keep our rates competitive.

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