Fixed spread and floating spread have their pros and cons. Follow these 5 comparisons between them to choose which one is best for you.
A spread is the gap between the bid and the ask prices of a security. In other words, a spread refers to the difference in a trading position – between a short position (sell-side) and a long position (buy-side). Basically, the spread refers to the difference between two prices, yields, or rates.
In lending, spread refers to the cost a borrower pays above the rate of a loan on average. For instance, if the prime interest rate is 6%, a borrower gets a credit charging an 8% rate. So, the spread is 3%. Meanwhile, in underwriting, the spread refers to the difference between the cost an underwriter pays to buy an issue of security, and the price an underwriter sells a security to the public.
There are two types of spreads in the financial market: fixed spread and floating spread. Fixed spread is the difference between the bid and the ask prices that remain fixed even though the prices are changing. On the other hand, floating spread is the difference between the bid and the ask prices fluctuating in a range and it usually follows the market dynamics.
Forex brokers are known to be capable of offering fixed and/or floating spread. As both have their pros and cons, follow these 5 comparisons between fixed spread and floating spread to choose which one is best for you:
1. Bid-Ask Range
Fixed spread shows that the difference between the bid and the ask prices of security remains the same amidst the changing of market conditions. For instance, the spread on the EURUSD will be fixed as 2 even though market condition fluctuates.
On the contrary, floating spread shows that the difference between the bid and the ask prices of a security fluctuates from time to time. Fluctuation of spread depends most on the market circumstances, notably during high-impact news release in which the spread could widen significantly.
2. Brokerage Models
Market makers offer fixed spreads in line with their clients' orders to positions. They can offer controlled pricing with fixed spreads because they have already assumed "in-house" via their dealing desk.
Meanwhile, market makers offer floating spreads because it is a feature with the non-dealing desk brokerages. The bid-ask range is subject to variation of market circumstances, volatility, etc. At the level of the prime brokers or the interbank market, there are many liquidity providers that offer different spreads for any single security.
3. Execution Costs
Execution cost is the gap between the execution price of a security and the price that should have existed in the absence of trade. In the rules of fixed rates, traders are able to count their costs before executing the trade. But, in the rules of floating rates, traders have to absorb the sudden spread changes. Therefore, the floating spreads can lead to higher execution costs for traders than fixed spreads.
4. Capital Requirements
Traders who use fixed spreads or floating spreads have different scenarios. For instance, traders with fixed spreads are usually trading in the short term and use capital no more than $9,999. In contrast, traders using floating spreads are usually trading in the long term and use capital bigger than $10,000. They aim for high capital gain whereas fixed spread traders tend to prioritize short term positions with smaller profits.
5. Effect on Trading Styles
There are some trading styles in forex trading such as scalping, day trading, swing trading, and position trading. The common difference between those styles depends mainly on the duration of trades.
Scalping refers to a typically short-term trades that can deal with a number of positions simultaneously during one-day trading. Day trading refers to a strategy capitalizing on the intraday market price action. For swing trading, price movements have great emphasis on the analysis as the general aim is to maximize profit from price swings.
Meanwhile, fundamental research has a big role in position trading as the strategy relies on the big-picture analysis and usually results in holding a position for weeks and even months. Position traders are less concerned with the news of the day and short term fluctuations unless they impact the long term view of their position. Basically, position traders trade passively with less than 10 trades a year.
Based on the abovementioned characteristics of trading styles, floating spread is usually the most useful for scalping and day trading. Meanwhile, fixed spread is more suitable for swing trading and position trading since both need spread's stability for the positions to work in a medium to long term. Whichever strategy you choose, it is imperative to practice it in a forex demo account before trying it for live trading.