Forex Insights: spread vs. commission

Forex markets are quickly gaining popularity not only within experienced investors, but also within new and individual investors. Many of those enter the forex markets to diversify their portfolio, and also to take advantage of no commissions charged and low trading costs offed by forex brokers. Even though forex markets provide lower trading costs than other investment markets, it is important to analyse the details of those costs involved.

Investors who are involved in stock trading most of the times have a trading account with a broker, and they have funds deposited in their account. Once he identifies a stock investment opportunity, an investor will send a trading order to the broker and the broker will go ahead and execute that order on behalf of the client. For the service of reception and transmission of the order by the client, the broker will be compensated by charging a commission to the client. With stock trading, the commission charged by the broker can be a fixed dollar amount for each trade, or a dollar amount for each share traded, or it will be linked on the size of the trade. For any of these cases, the commission will be charged on both sides of the transaction. This means that the commission will be applied on the purchase of stocks and also on the subsequent sell of those stocks at a later stage.

Forex brokers, like stock brokers, also receive and execute trading orders on behalf of their clients but they do not charge any commission fees. They get compensated for offering their services by charging the traders with a spread. The spread is the difference between the price that the forex broker is willing to pay to the trader for buying the currency (the bid price) and the price the forex broker is willing to receive from the trader for selling the currency (the ask price). Take for example the following quote:

The spread in the example is three pips, the difference between the bid and ask price. Forex brokers add the spread on the price of a trading position, and it is their fee for opening a trade.

Spread is different than commission, but it serves the same purpose of compensating the forex brokers for the services they offer. However, the spread has the advantage of being applied only on the one end of the transaction. In other words, it is charged only when opening a trading position and not charged again when closing the trading position.

Because the spread is the primary trading fee, it is important to be aware of the different offers that forex brokers have. Spreads vary dramatically according to the currencies traded and account type, with popular currency pairs having lower spreads than more exotic currency pairs, and VIP accounts enjoying lower spreads than standard accounts. Some forex brokers offer variable spreads that seem to be low, however those spreads widen as soon as the markets become more interesting or volatile. Variable spreads are in contrast with fixed, or guaranteed, spreads which remain the same at all cases and they offer more transparency on the cost involved in trading a currency pair. Some selected brokers offer conversion of account funds to local currency at mid rates, so that they don’t charge any fees on client deposits and withdrawals.

The spread is the primary association with forex trading costs, and there is a variety of spread offers that forex brokers have. Tiny spread differences might seem negligible, but marginally higher spreads will prove costly as the number and volume of trades becomes larger. Traders should make sure that they pick their forex broker wisely by considering the different spread types that they offer.

This article has been contributed by David Parker, investment entrepreneur and marketing consultant for www.easy-forex.com.