COMPARING FOREX SPREAD
Whenever you trade in the forex markets (except when you use a limit order) you will pay a forex spread – the difference between the bid-ask price. This ought to make it easy to compare spreads among different forex brokers, but unfortunately, it isn’t quite that easy… Brokers employ one of a number of different execution models. In order to make meaningful comparisons, it is necessary to understand a little more about these.
An ECN is an ‘electronic communications network’, and is how banks and liquidity providers interact to exchange currencies. ECN brokers provide direct access to this interbank market, where forex spreads are extremely narrow, and charge a commission for doing so.
Quite often these brokers are keen to identify themselves as such. There is some perception that the ECN model provides greater transparent and removes the potential for conflicts of interest. The broker makes their profit from the fixed commission they charge. For this reason, they have no motivation to game the bid-ask spread in any way. However, interbank spreads are extremely sensitive to market volatility and liquidity shortages hence can become prohibitively wide during events such as news releases.
Dealing Desk Brokers
Brokers who operate a dealing desk model make their money from the bid-ask spread. They act as counterparty to their client’s trades and therefore control the bid-ask spread. Because they make their profits from the inflated spread they do not charge commissions. Often, dealing desk brokers choose to provide ‘fixed spreads’. This means that the bid-ask spread is guaranteed at a certain amount regardless of how wide or narrow the ‘floating spread’ in the market may be.
An STP or ‘straight-through-processing’ broker occupies the middle ground between the two models described above. An STP firm will pool the best bids and offers from its liquidity providers, inflate the forex spread, and then enable you to trade at these prices. There is no dealing desk intervention and prices are based upon (though inflated from) those found in the interbank market. Bid-ask spread are always floating and never fixed, and no commissions are charged.
An important first step when comparing brokers is, therefore, to identify which of the above categories a firm falls into. Then you can begin comparing them with similar companies to determine which will be the most suitable. Remember, however, that trading fees are by no means the most important priority when choosing a forex broker.