In our previous article "Detailed Explanation of the Profit Model of Foreign Exchange Trading Platforms", we discussed in detail the profit models of various foreign exchange platforms.
Market makers make profits through spreads and betting; ECN makes profits through commissions; STP makes profits through a slight increase in bank spreads. So what exactly is the spread? We will give you a detailed explanation today.
1. What is the spread?
There are unavoidable problems in any business model: income, cost and profit. For a foreign exchange trader, he will quote a buying price (ask) and a selling price (bid) when quoting, and the difference between them is the spread, which we can understand as the difference between the bank's deposit interest and loan interest Difference, this is the survival mode of STP foreign exchange traders. Its essence is the difference between the bid price and the ask price.
So what is a "point"?
In order to express the exchange rate accurately and conveniently, it is generally represented by 5 digits, and the smallest unit of change is usually called a "point". For example, the smallest unit of the quotation 120.00 of USDJPY is 0.01 yen, or 0.01 yen for 1 point. GBPUSD (GBPUSD) quote 0.9800 minimum unit is 0.0001 US dollars, or 0.0001 US dollars is 1 point. Therefore, between different currencies, the decimal places on the numbers are also different.
From an investor's point of view, the handicap is the cost of the transaction. Of course, the smaller the handicap, the more beneficial it is for investors. In general, currencies with high circulation have lower spreads than currencies with low circulation.
2. Classification of spreads
Spreads can also be divided into fixed spreads and floating spreads. Fixed spreads mean that spreads are always fixed, no matter how the market changes; floating spreads change with market changes. The greater the liquidity and trading volume of the market, the smaller the spread ;Conversely, the smaller the transaction cost, the larger the spread, and the larger the transaction cost.
【1】Fixed spread:
The fixed point difference is unintelligible, which means that in foreign exchange transactions, the difference between the buying price and the selling price of the trading variety is fixed. The fixed spread will not change with the change of trading volume, so it is called fixed spread. In the market, most MM (market maker model) platforms will adopt a fixed spread model. There will be many restrictions on some platforms for fixed spread trading, such as scalping trading, ultra-short-term trading, etc.
【Advantage】:
The advantage of fixed point difference is that the transaction cost is fixed, regardless of any changes in market trading volume and circulation, the value of the difference between buying and selling is always fixed.
[Disadvantages]:
Due to the fixed transaction cost and the lack of liquidity of products under certain data market conditions or violent market conditions, the fixed point difference will cause the difference between the buying price and the selling price to widen, that is, the spread will widen. It is very likely that the transaction cannot be executed or the quotation will be repeated.
Many foreign exchange traders feel that fixed spread mode trading is not very sensitive, mostly because the spread is fixed and does not change with liquidity changes.
【2. Floating spread】:
Traders adjust the bid-ask spread according to their own costs, which is the quotation mode provided by ECN traders. Because ECN traders do not manually quote, nor manually modify data to trigger stop loss. Pass the transaction directly to counterparty customers or more than 12 large banks (customers and banks are like water in a big pool), and these banks provide market liquidity.
【production methods】:
The selling price of Bank A is 1.5006, the buying price is 1.5003,
The selling price of Bank B is 1.5007, the buying price is 1.5004,
The selling price of Bank C is 1.5008, the buying price is 1.5005,
Assuming that the three banks A, B, and C are the quotation banks of the platform provider, then the optimal price obtained by the platform provider is, the buying price (corresponding to the bank’s selling price) A: 1.5006, and the selling price (corresponding to the bank’s buying price) C: 1.5005. At this time, the best trading spread is obtained. If the spread of Bank C suddenly widens, the platform operator will not be able to obtain the advantage of the spread just now.
The spread of the bank itself is adjusted according to the degree of market risk. During the Lehman bankruptcy stage in 2008, the period of non-agricultural data and other risk periods, the spread of the bank will increase, so the spread of the floating spread platform will naturally increase.
【Advantage】:
Suitable for mature foreign exchange traders with large funds, a small commission is charged for each transaction.
[Disadvantages]:
The floating spread will increase, and there will be risk exposure in cost.
3. How to reduce transaction costs
In foreign exchange trading, the spread is the main cost of foreign exchange transactions. Of course, the smaller the spread, the lower the transaction cost, and the larger the spread, the higher the transaction cost. Don't think that every transaction will cost a lot of money. The cost is terribly high. In fact, compared with the spread, the transaction funds are already very economical. But as traders, we still have to keep reducing costs. How to reduce transaction costs?
【1】. Choose foreign exchange dealers and trading platforms with small spreads
【2】Buying and selling currency pairs with good liquidity, such as the euro, British pound, and Japanese yen, generally have relatively small spreads, but the spreads of currencies such as the ruble are scary.
【3】Don't buy and sell frequently. Small spreads don't seem to be much. If you make a lot of transactions every day, the fee will be quite a lot. Of course, if you are doing scalping, you have to check whether your platform provider allows this.
【4】For those who have just entered the market, the fixed spread also has a certain role in protecting investors. Therefore, fixed point difference, small capital, suitable. If the funds are large, floating spreads are adopted, and the commission model is good.
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