Let me talk spreads for a minute or two
I want to take some time to talk about the spread, speciifically, the bid-offer or bid-ask spread.
You see, in every market there is a bid-offer spread of some kind. Depending on how we trade, we don’t always see it, but it’s there. Stocks have them. Futures have them. Forex has them. Fixed Income has them. Most of the time they don’t matter very much, but in some cases they can be important.
I bring this up because in discussions of whether trading forex via the futures or spot market is better, you often hear people include among the arguements in favor of the former the fact that there are spreads in spot, but not in futures. That is completely false.
Any time you have bids and offers – which is any time you have a market – there is a spread. They are just more visible in the spot forex market because the price feeds we see there are indicative quotes (indicating where trading could take place), not actual traded prices as we see coming from the futures exchanges. I know, however, that when I go to place a futures market order I can get a bid-offer quote, and the order book displays some platforms allow you to see shows bids and offers, and there most certainly is a difference between the two.
Now, what I will go along with is the argument that futures spreads can be narrower than spot ones in forex, especially in the actively traded e-contracts. Spot forex spreads have come way down in recent years, though, due to increased competition, so you can’t always say the futures spreads are better anymore.
The reason this is even important is the fact that the bid-offer spread represents a kind of hidden transaction cost in trading. Unless you are trading via direct access in one way or another where you can dictate your prices and essentially act as the market maker after a fashion, you will be buying on the offer and selling at the bid. That means you automatically lose the spread. The wider the spread, the larger that loss. And of course that is on top of any commissions you might already be paying your broker.
If you are a position trader you really need not worry over much about the spread. You are not trading frequently enough for it to hurt you (unless for some reason you are only taking very small profits). It is more the day trading sort that must concern themselves with the gap between the bid and the offer because they trade in and out frequently, taking smaller profits which can be significantly eroded.
Here’s the one thing to look out for, though. Inactive markets have wider spreads, sometimes to the point of being difficult to trade. In forex, the non-major currencies like the South African Rand have very wide spreads. The market would have to move significantly to make a trade worthwhile. Stock options can also have quite wide spreads simply due to low volume. Keep these things in mind when you are trading. It could make a difference in your results.
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