Ten Key Factors that Influence Spreads in the Forex Market

The spread in forex refers to the difference between the bid (the price at which buyers are willing to buy a currency pair) and the ask (the price at which sellers are willing to sell a currency pair). The spread is typically measured in pips and represents the broker’s profit. Several factors influence spreads in the forex market.

Here are 10 key factors to look at.

1. Market Liquidity

You get high liquidity and low liquidity. In highly liquid currency pairs, where there are many buyers and sellers, spreads tend to be narrower because it’s easier to match orders. In less liquid markets, spreads can widen as there are fewer market participants, making it more challenging to execute trades at desired prices.

2. Market Volatility

The market can have either high volatility or low volatility. During periods of increased market volatility (high volatility), such as major economic announcements or geopolitical events, spreads can widen as uncertainty prompts market makers to increase the premium for executing trades. In calmer market conditions (low volatility), spreads may narrow as the risk for market makers decreases.

3. Broker Policies

Different brokers may have different policies regarding spreads. Some brokers offer fixed spreads, while others offer variable spreads that can change based on market conditions. It’s always a good idea to do a forex broker platform comparison, to compare brokers, so that you can see what they can offer you.

4. Market Maker Practices

Some market makers engage in “re-quoting” practices, where they may adjust the quoted price before executing a trade. This can result in wider spreads, impacting the entry and exit points for traders.

5. Economic Indicators and News Events

The release of economic indicators and major news events can lead to sudden spikes in volatility, causing spreads to widen temporarily. That is why it is important to keep up-to-date with forex market news.

6. Time of Day

Spreads can vary depending on the time of day. During the most active trading sessions (overlap of major financial centres like London and New York), spreads are generally narrower compared to less active periods. According to Investopedia “The U.S./London markets overlap (8 a.m. to noon EST) has the heaviest volume of trading and is best for trading opportunities. The Sydney/Tokyo markets overlap (2 a.m. to 4 a.m.) is not as volatile as the U.S./London overlap, but it still offers opportunities.”

7. Currency Pair

Major currency pairs (e.g., EUR/USD, USD/JPY) typically have lower spreads because they are more liquid and have higher trading volumes. Your exotic or minor currency pairs (e.g. NOK/TRY, USD/ZAR) may have wider spreads due to lower liquidity.

8. Size of the Trade

Larger trade sizes may experience wider spreads, especially in less liquid markets. Larger orders may need to be filled at multiple price levels, contributing to increased spreads.

9. Global Events and Geopolitical Risks

Political events, such as elections or geopolitical tensions, can increase market uncertainty and lead to wider spreads as traders demand more compensation for risk. Keep an eye on the global news sites.

10. Central Bank Interventions

Actions taken by central banks or governments to stabilise or manipulate their currencies can lead to sudden and significant changes in spreads.

Traders should remain vigilant and consider these factors when assessing potential trades. Additionally, understanding the specific policies of the broker being used, through doing a forex broker platform comparison, is crucial for effective risk management and cost control. Keep in mind that market conditions can change rapidly, influencing spreads in real time.