24. Why do the spreads sometimes become wider or narrower?
The non-fixed spread
“Spread” refers to the difference between the bid and ask price of a currency pair in forex trading. The widening or narrowing of the spread is directly related to the cost of investors in the trades. This cost is not paid directly, but is hidden and latent. When the spread is wide, investors may not be able to buy or sell at the best market price regardless of whether they enter or leave the market. In other words, it is a cost that affects the room of profit of investors.
In the international forex market, the spread of currency pairs floats all the time, so the potential costs can be larger or smaller. The floating spread is affected by how high the market trading volume, that is, “liquidity”. Generally speaking, the more people that trade in a currency/currency pair, it means that there are more counterparties in the market, whether buying or selling, who are willing to undertake and make trades close to the current market price, causing a narrower spread.
However, once the trading volume is low, the number of transactions that can be matched naturally decreases, eventually leading to a wider spread.
At present, most forex brokers only provide clients with an online trading platform and do not intervene in clients’ trading. Instead, they send clients’ orders directly to the forex market for matching. Therefore, what investors see is the normal market price with a floating spread.
When will spreads be widened?
The international forex market is formed with the participation of individuals, enterprises, banks, various brokers, insurance companies, investment institutions, central banks and governments, etc. The market liquidity is extremely high. As mentioned above, the changes of spreads are affected by market liquidity, so most of the time in the forex market, such changes are just very little and will be maintained within a certain tiny range.
However, sometimes the spread of the currency pairs will become wider which are mainly under three circumstances:
First, economic data announcement. In particular, the release of important data such as central bank interest rate, national GDP, non-farm payrolls of the United States.
Second, thin market trading. For e.g., some markets are closed on holidays, and the period after the US session closing and the early session in Asian session with low trading volume.
Third, major risk event or breaking news. Some unpredictable events, such as political change and instability, terrorist attacks, disruption of actual supply and demand, black swan events, etc.
All of the above can suddenly reduce the liquidity in the forex market as market participants may trade less or stop trading. In many cases, ahead of important economic data and policies, uncertainty keeps investors cautious and on the sidelines, making spreads widen as buy or sell orders disappear. If the final outcome is beyond the expectations of the market, causing fluctuations in the market, the spreads maybe even further wider.
Next Articles: 25.What is slippage?
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