Strategies and tips on navigating the forex spread

Now that you understand what a forex spread is and what factors influence it, we’ll explore some of the top spread trading techniques. You’ll also learn how to protect yourself against a widening spread.

Beware a widening spread

As you may know by now, the spread is the primary cost involved in forex trading. So a wider spread will ultimately lead to a larger trading cost.

Times of high volatility, illiquid currency pairs and leverage (among other factors) could affect the total fees you pay on your trades. If you combine the three techniques below, you can reduce the risk of trading at a high spread.

Consider using these steps when both executing and closing a trade because the spread may also change from when you open the position to when you want to close it.

Keeping an eye on factors that affect the size of the spread

Here’s a quick recap of the three main factors that affect forex spreads:

• Volatility: dramatic movement in a currency pair’s price that can be brought about by economic data releases, a breaking news event or low liquidity

• Liquidity: less participants trading on a market could also cause a spread to widen as dramatic price changes can happen

• News: before a popular news or market event, liquidity providers may widen their spreads to offset some of their risk

News and economic data releases can have a big impact on a market’s price movements. However, the spread will usually revert to its mean after a few minutes following an event, so it could be advantageous to wait and only act when the spread narrows.

For example, if you wanted to trade USD/JPY, you might consider checking on upcoming shock-events or data releases that could affect its spread. You can do this by keeping informed on the latest news and using an economic calendar.

Below is a sample from an economic calendar. Events with a ‘high impact’ have a higher chance of increasing the spread. So unless your strategy involves trying to capitalize on the releases, it’s better to trade around these events.

Some events that could increase volatility and forex spreads include:

• Gross Domestic Product (GDP) releases: the total value of a country’s finished goods and services during a specific period

• Consumer Price Index (CPI): a measure of changes in consumer goods prices of a country (or inflation data)

• Non-farm Payrolls (NFP): a monthly report, typically released on the first Friday of each month, that highlights the number of economically active people in the US, excluding farm workers

Choosing high-liquidity forex pairs

Another strategy many traders – particularly beginners – adopt is choosing high liquidity forex pairs. Under normal market conditions, major currency pairs will usually have the lowest spread. Examples of these are:

• EUR/USD
• USD/JPY
• GBP/USD
• USD/CHF

This is because they usually trade in high volumes. However, you may notice that they don’t always trade at low spreads. Remember, liquidity is only one factor that could influence the spread. These forex pairs are also influenced by market volatility and the news.

Since emerging market currencies generally have higher spreads compared to major pairs, a strategy some traders use is to trade them in smaller lot sizes than they would with major pairs.

The image below shows two major currency pairs – USD/JPY and EUR/USD – as well as AUD/CNH and CAD/CNH which are both emerging market pairs.

The major market currency pairs, USD/JPY and EUR/USD, have narrow spreads. – 0.7 and 0.6 pips, respectively. On the other hand, the emerging market currencies, CAD/CNH and AUD/CNH, have much wider spreads.

Trading during key times of the day

The time of the day influences forex spreads, so it can be useful to factor this in when creating your strategy.

During major market trading sessions – like London, New York, Sydney and Tokyo – forex spreads are normally at their lowest due to the high volume of currency being traded.

You could trade during these times to take advantage of narrower spreads. Further, when the London and New York sessions overlap, spreads can become even narrower – making this an ideal time to trade these markets. This happens between 8am and 11pm (Eastern time).