5 Factors That Influence Spreads When Forex Trading

When trading forex, you will need to pay your forex broker the spread which is the difference between the bid and ask prices of a currency pair. There are many variable factors that can impact the size of the spread including the brokers liquidity, trading volumes, economic data and market sentiment. If there is an imbalance between the buyers and sellers of a currency pair, the spread can widen to reflect this market condition.

EURUSD Currency Pair Spread
EURUSD Currency Pair Spread

Generally speaking, the tighter the spread, the less it will cost you to make a trade. Some forex trading strategies like scalping are especially dependent on having a tight spread. There are a few factors I believe are worth considering if a trader is looking to try and avoid high spreads. In this guide we will look at 5 factors that can have an impact on forex spreads.

1. Avoid trading exotic currency pairs

Exotic currency pairs such as the EURTRY and USDZAR tend to have higher spreads than major currency pairs such as the EURUSD and GBPUSD. The difference in spreads is primarily due to the popularity of the currency pairs. Those with less trading volume and demand will usually have a lot less liquidity and thus the spreads are increased to compensate for this.

Forex Spread On Exotic Currency Pair NOKSEK
Forex Spread On Exotic Currency Pair NOKSEK

2. Trade during the most active trading hours

Fore spreads can be greater when trading outside of the most active global trading hours. You can refer to forex market hours to see different trading sessions. The less trader there are in the market, the less liquidity there is to supply bid/ask prices. As the number of participants in the market increases, the spreads as a rule tend to narrow as there are plenty of buyers and sellers for any given price of a currency pair.

The overlap of the London and New York sessions, which is between 12:00 PM and 4:00 PM GMT is widely regarded as one of the most active times of the day on the Forex market. This is therefore the point in time when some of the biggest price fluctuations can occur. On the contrary, the pre-Asian session just after the New York close and during the rollover, can have some of the widest spreads due to lack of liquidity.

3. Avoid trading around major news releases

It is normal during major news releases for spreads to widen significantly which can cause unsuitable trading conditions for many strategies. Important news can include reports on economic growth, inflationary reports, interest rate changes and non-farm payroll (NFP). Some forex traders will refer to an economic calendar in order to avoid trading around the news altogether. Not only can spreads be wide during news but market movements can be extremely volatile.

4. Weekend gaps and the spread

If you look at your currency pair charts when the forex market reopens on Sunday, you will most likely see a significant gap between the closing price on Friday and the opening price on Sunday. This is known as the “weekend gap”.

Whilst some forex traders have made strategies dedicated to trying to take advantage of this gap closing, usually the spreads are very wide and can even go into double digits of pip on major currency pairs such as the EURSUD which are usually much lower.

5. Forex brokers and the spread

One of the most important factors that affect spreads from my perspective is the quality of the forex broker. I find that those with the most liquidity providers (LP’s) will have the tightest possible spreads as they source the bid/ask price from multiple execution venues and pool them together into one deep liquidity pool to offer traders the best spreads possible.

In my experience, an ECN forex broker will usually always have the lowest spreads which can save me on my trading costs in the long term. In addition to tight spreads, I also find that an ECN brokers have rapid trade exaction speeds with minimal slippage.

Forex Spreads Conclusion

Hopefully you now have an understanding on some of the various factors that can impact the spreads that you pay when trading forex online and how to avoid them. Some trading strategies are reliant on tight spreads whereas others may not be so spread dependent. Either way, tighter spreads can help to save on trading cost in the long run.

If it is not possible to avoid high spreads as you want to trade specific currency pairs and market hours, then perhaps it may be worth considering using a trading strategy that is not solely dependent on tight spreads. You probably wouldn’t want to try scaping on exotic currency pairs during quiet market hours but the spread may not matter so much if taking long term positions.

I would personally always use an ECN forex broker for the best possible trading conditions, including tight spreads and reliable trade execution speeds. If you are looking for a broker to trade online with, please feel free to take a look at my best forex brokers page.

Happy trading!