Impact of Spreads in Spot Gold Trading
Nothing affects your profitability more that spreads in spot gold trading in the Forex market. Spread is an essential part of Forex trading that many traders new to the scene of Forex trading tend to overlook. Spread significantly influences the amount of profit that you can make from trading gold in the Forex market. Almost all online forex brokers claim that they offer the tightest spread for the consumer. Yet, how can you tell if the spread offered by the online Forex broker is best for you? How can you determine the impact of forex broker spreads on online Forex spot gold trading?
In order to understand the influence of spreads on online Forex trades, you have to understand what is meant by spreads.
What is Meant by Spread in Forex Trade?
In Forex, a spread is the amount of difference between the bid and ask prices of currency pairs. This difference is measured in PIPS (Percentage in Points).
Bid price is the price the forex broker buys currency pair from you, while ask price is the price at which the broker sells currency pair to you. You should remember that the bid price is always lower than the ask price. The difference between the two prices is the bread and butter for these online brokers who finance their operations through this spread.
Brokers offers two types of spreads to online Forex traders. These include:
- Fixed Spreads
- Variable Spreads
Fixed spreads, as the name suggests, remains fixed for a particular currency pair. For example, if the online broker offers a spread of 2 or 3 pips for XAU/USD pair, it will remain fixed unless and until the broker changes its terms and conditions.
Variable spreads on the other hand fluctuate and depends on certain market factors. Liquidity of the currency pair is one of the factors that may determine the spread value. Variable spread of the currency pair fluctuates in value by moving up and down a specific range depending on the market factors.
How Spread Influences Forex Spot Gold Trading?
Spread strongly influences the amount of profit you can make from the Forex trade. It indicates the transaction cost of the trade. In effect, spread determines how much profit you can make from currency pairs traded in the Forex market.
Lower spreads are preferable as it means that currency pair values have to change little to earn profit from the trade. Higher spreads generally require greater profits and it may sometimes become difficult just to break even from the trade.
For example, suppose the spread of the currency pair XAU/USD is 2 pips. It means that on buying the currency pair, it has to increase in excess of 2 pips to make profit from the trade.
Spread and Volatility
Although the amount of spread determines the profit earning potential of a currency pair, you should not look at spreads alone to make your decision about selecting a particular currency pair. Volatility of the currency pairs should also be looked into to determine the profit earning potential of the currency pair.
A currency pair that has low volatility can be an expensive buy, even if it has low spread. On the other hand, a currency pair that has high volatility can be a cheaper buy even if it has a high spread. Therefore, it is important that you look at the volatility of a currency pair in combination to spreads to determine whether it is an attractive buy or not.
You can determine the volatility of a specific currency pair by looking at the Average True Range (ATR) figure. Currency pairs with higher ATR are generally preferable to lower ATR. An example will help you clarify the link between volatility and spread.
Suppose, that XAU/USD pair has ATR and spread of 94 pips and 3 pips respectively, while XAG/USD has ATR and spread of 45 pips and 2 pips respectively. The volatility of gold currency pair is higher than silver currency pair while the spread is also higher. But the best buy is the gold currency pair since its spread as a percentage of currency movement is 3.30% (94/3) as compared to 4.65% (45/2) of the silver currency pair.
Even though silver currency pair has a lower spread value, its low price volatility makes it an expensive buy as compared to gold currency pair.
When most of us think of currencies, we think in terms of exchanging money to travel abroad. Investors, banks and international companies, however, think of currencies as assets. While some people buy stocks on the NASDAQ or the New York Stock Exchange, others trade currencies on the Forex (Foreign Exchange market). The Forex is a global exchange. It is the most widely traded financial market in the world with a four trillion dollar daily volume.
In addition to almost 50 different currency pairs, silver and gold Forex trading is also available. Why are silver and gold in a currency market? These precious metals have long been popular investments and are viewed as currencies in their own right. They can be used as a hedge against currency valuations and economic disasters, or trading gold can simply be a speculative option.
Silver and gold Forex trading is similar to the other currency transactions. The margin requirements are larger, and currently the USD is the only paired partner. However, the basic process is the same, and it is not that complex.