Forex spread trading – strategy & other tips

The spread in forex trading refers to the difference between the sell (bid) and buy (ask) prices of a currency pair. Forex traders typically earn gains from spread fluctuations in different market conditions. The attempt to profit from a change in the spread (i.e., when the spread widens or narrows) is called spread trading.

What types of spreads are there?

There are two types of spreads, fixed and variable.

Fixed spreads stay the same, regardless of market conditions. They typically have smaller capital requirements, making them ideal for beginner traders or for those with a limited budget. Transaction costs are also more predictable. Requotes can however occur more frequently, and the risk for slippage is high.

In contrast, variable spreads are always changing – widening or tightening based on market volatility and supply or demand of certain currencies. They are typically more suited to experienced traders. With variable spreads, there is no risk of requotes and pricing is usually more transparent. They can however turn unprofitable very quickly.

How is spread measured?

Spread is typically measured in pips. This is the smallest unit of the price movement of a specific currency pair. One pip is usually equal to 0.0001. The spread may vary from broker to broker. It is however also influenced by volatility and the volumes traded on a particular instrument. The most popular currency pair in forex is the EUR/USD, and usually offers the lowest spreads.

What drives forex spreads?

Forex spread can widen or narrow due to a variety of factors. For one, the time of day a trade is executed can largely impact spreads. In other words, if a currency is traded outside of its usual trading hours (e.g., euro trade opened during the Asia trading session), the forex spread on that trade may be wider due to lack of liquidity bought about by lack of trading activity. Other factors impacting forex spreads include economic and geopolitical news, events, or announcements. These may cause the forex market to become incredibly volatile with extreme exchange rate fluctuations. This typically results in forex spreads becoming extremely wide.

Forex spread trading strategy

Considering the factors impacting forex spreads, using an event or news-driven strategy for spread trading could be beneficial.

What is an event or news-driven strategy?

This approach focuses on making trading decisions based on specific news, events, or economic indicators. It involves identifying key events that could result in currency price fluctuations and executing trades based on anticipated outcomes of those events.

How does the trader identify key events?

To do this, a trader will typically monitor economic calendars, news publications and other sources of financial information. They will seek to identify factors like geopolitical developments, economic data releases, central bank announcements, environmental concerns, etc.

What does the trader do once market-moving events are identified?

Once possible market-moving events are identified, a trader will assess the potential impact of the events on currency pairs. They will also analyse how the news will affect inflation, interest rates, economic growth, and other factors influencing specific currencies. Based on their assessment, the trader will then decide whether to take a long or short position in a particular currency pair before the event occurs.

What happens as the event or news unfolds?

As the event or news occurs and the market reacts, the trader will typically execute their positions based on the actual outcome. The decision to execute the trade will also depend on how it aligns with the trader’s initial analysis. A trader must respond quickly however to be able to capture potential trading opportunities.

How important is a risk management plan?

Having an effective risk management plan in place is one of the most important aspects of forex trading. This applies regardless of the trading strategy you choose to implement. The mercado de divisas is after all the most active financial market in the world, also making it one of the most volatile. Add to this the use of leverage, and that volatility is amplified substantially. This means that unless your trading is properly managed, you stand the risk of being exposed to large, unanticipated losses.

In order to mitigate the risks involved in forex or spread trading, the use of risk management techniques is key. Let’s take a closer look at what these are:

• Stop-loss order. A stop-loss order is an instruction to close a trade at a specific price level to limit losses. A trader does this by setting the maximum amount they’re willing to lose on a trade before it automatically closes.
• Take-profit order. Like a stop-loss order, a take-profit order enables a trader to lock in profits when the trade reaches a specific level. This ensures the trader exits the trade before the market reverses adversely.
• Position sizing (tamaño de la posición). This involves establishing an appropriate position size for each trade that aligns with your tolerance for risk and account balance.
• Diversificación de cartera: Diversifying one’s portfolio ensures that risk is spread across several assets. This minimises the impact of losses on your overall trading portfolio. Diversification entails not putting all your funds into a single currency pair or trade.
• Managing leverage. Leverage (Apalancamiento) can amplify gains but also magnify losses. The requires that you remain vigilant when using leverage to ensure you don’t become overly ambitious, leading to adverse trading outcomes.
• Getting a handle on your emotions. Trading de forex, irrespective of the strategy, can be very taxing on one’s emotional state of mind. It is a highly stressful and emotive activity. One that involves knowing how to get a handle on feelings of greed, fear, impulsion, etc. Be mindful of emotions to ensure they don’t impact your trading decisions negatively.
• Continuously monitor your trades. One of the most effective risk management techniques is to keep a trading journal. This provides you with a historical reference of your trades and can help you identify patterns in your trading activity. It also enables you to identify your strengths and weaknesses and to learn from your mistakes.

Open a demo account to practice your Forex trading strategy

One of the best ways to test your forex trading strategy is to practice it on a demo trading account. You can open a demo account with a CFD forex broker like IronFX which will give you access to a simulated trading environment in which to practice your trades, strategy, and techniques. Using virtual funds, you can implement all manner of trades, using technical or fundamental analysis, without putting your own money at risk.

IronFX also gives you access to extensive educational resources to help you boost your trading skills and knowledge. This includes podcasts, webinars, blogs, glossaries, videos-on-demand, and much more. Through these resources, you can acquire all the information, tips and ideas for trading forex. Equipping yourself with these crucial insights will also help you build enough confidence and expertise to move on to live trading.

Exención de responsabilidad:

Esta información no se considera un consejo de inversión ni una recomendación de inversión, sino una comunicación de marketing