ForexNewsNow – The forex market offers traders the deepest and most liquid markets in the world. With a daily turnover calculated at almost $4 trillion, the fact that foreign exchange brokers do not charge commissions but instead make a part of the bid offer spread makes perfect sense.
Buying on the bid and selling on the offer in the forex market gives an online forex broker ample room to make substantial commissions dealing with their own customers trading in an online trading account, or offsetting trades with another dealer or market maker.
Bid offer spreads in the forex market vary considerably depending on the currency pair. Major currencies generally have tighter spreads and trade with a greater degree of liquidity than spreads on minor currencies or cross rates.
Currency Pair Characteristics that Determine Spreads
Each currency pair has certain dynamic features which determine the level of risk upon which a dealer or online forex broker makes their bid offer spread. For example, the EUR/USD currency pair trades in long sweeping moves and generally in a prolonged trend in a normal market.
Recent developments with the European financial crisis have increased volatility in the EUR/USD rate, raising the level of risk and as a result, dealers quote a wider bid offer spread. Bid offer spreads can widen or narrow depending on the level of perceived risk in the currency pair.
The GBP/USD currency pair, trades with a higher level of volatility, therefore increasing the risk level and hence, gives dealers a good reason to quote a wider bid offer spread. Most foreign exchange brokers offer similar spreads in all the major currency pairs.
Bid Offer Spreads Currently Used for the Majors
Bid offer spreads vary from broker to broker and from different financial institutions, with the size of the deal making a difference to foreign exchange brokers. Nevertheless, if you are trading an online trading account, your online forex broker will generally have either fixed or variable rates depending on whether they take the other side of their customer’s trades or they use another dealing desk to fill orders.
Spreads on the Major currency pairs used currently in the forex market:
- EUR/USD – 1 to 3 pips
- USD/JPY – 2 to 4 pips
- GBP/USD – 4 to 5 pips
- USD/CHF – 4 to 6 pips
Other Factors That Influence the Bid Offer Spread
Under normal market conditions, the above bid offer spreads would be accurate. Nevertheless, certain market conditions can cause market makers and dealers to widen their spreads. Important economic releases such as a country’s GDP number, employment numbers or inflation indicators such as the Consumer Price Index will all have an impact on the currency’s market.
A look at the market in a currency pair just before an important economic release will often show wider bid offer spreads, with dealers narrowing the spread once the market has calmed down after the release. Dealers will often narrow their spreads in quiet markets to attract more business.
Other important factors which influence the bid offer spread in the major currency pairs consist of major international news, central bank interest rate decisions and currency interventions. Political events such as national elections can also influence the way dealers make markets.
Spreads in the commodity currencies and cross rates tend to be wider, in part due to the increased risk in the commodity currencies and also because of the lower level of liquidity. Cross rates also have an increased tendency to trend, making dealers widen their markets even further.