November 5, 2008
Options Trading Mastery: Vertical Spread Test Scenario
Let’s put together what we’ve been talking about, develop an imaginary spread scenario and set it in real life events.
In October, let’s say that you begin to hear about IJK stock. It looks interesting, so you then use a variety of sources to learn about IJK: news, charts, outside analysts, internet research etc. From your investigations you decide that this stock is poised for a strong upward move and you’d like to take advantage of it.
However, each share is $50.00 and you question whether you want to put out the capital for enough shares to make the trade worthwhile.
Now is the time to investigate IJK spreads. Since you are bullish on the stock, you investigate the bullish plays of the call spreads and the put spreads. You check the pricing of both since you are aware that implied volatility and time decay will affect both your purchase price and your selling price if you decide to sell out the spread before expiration.
Let’s say that you set the spread’s maximum potential gain at $10.00 using our formula. Then you decide you want to buy a call spread, so you buy 10 IJK Nov. 50 calls and sell 10 IJK Nov 60 calls. The spread is called Nov. 50-60. The spread’s cost is $3.50, which means you pay $3500 for the trade, inexpensive when you consider that to purchase 1000 shares of IJK stock would have cost you $50,000! Now, you wait and follow the stock price of IJK. If you hold the position to expiration, you face the following losses or gains.
First, if the stock does not move up as you expected and stays at $50 or decreases in value, your spread is worthless and you lose the $3500 that you paid for the spread. Second, if the stock begins to move up, you first recoup your investment and then move into profits. After the stock has moved up $3.50 you are at the breakeven point. Every money advance after that represents profit.
The chart below represents the spread’s losses and gains and your total profit
This chart is based on stock prices at expiration Friday in November. Until then the spread’s value fluctuates between $0 and its maximum (the difference between strike prices) of $10.00
At any time until expiration, you can sell out of the spread but what you receive for the price may be influenced by implied volatility and time decay and that will change your profit or loss. If you hold the spread until expiration and your bullish lean proves true, your maximum profit on your $3500 investment is $6500.
You paid $3500 for the spread and received $10,000 at expiration with the stock at $60.00. That represents a $6500 profit which is a 186% return.
If you had invested $50,000 for 1000 shares of IJK and at expiration sold the stock for $60,000, your profit is $10,000 for a 20% return.
For many investors the reward/risk scenario of the spread is attractive because investors can limit the capital at risk and the time of risk/reward exposure. The spread also offers protection if your lean is bullish or bearish. Finally, the spread has the potential of a large percentage return on investment.
By: Ron Ianieri
About the Author:
In October, let’s say that you begin to hear about IJK stock. It looks interesting, so you then use a variety of sources to learn about IJK: news, charts, outside analysts, internet research etc. From your investigations you decide that this stock is poised for a strong upward move and you’d like to take advantage of it.
However, each share is $50.00 and you question whether you want to put out the capital for enough shares to make the trade worthwhile.
Now is the time to investigate IJK spreads. Since you are bullish on the stock, you investigate the bullish plays of the call spreads and the put spreads. You check the pricing of both since you are aware that implied volatility and time decay will affect both your purchase price and your selling price if you decide to sell out the spread before expiration.
Let’s say that you set the spread’s maximum potential gain at $10.00 using our formula. Then you decide you want to buy a call spread, so you buy 10 IJK Nov. 50 calls and sell 10 IJK Nov 60 calls. The spread is called Nov. 50-60. The spread’s cost is $3.50, which means you pay $3500 for the trade, inexpensive when you consider that to purchase 1000 shares of IJK stock would have cost you $50,000! Now, you wait and follow the stock price of IJK. If you hold the position to expiration, you face the following losses or gains.
First, if the stock does not move up as you expected and stays at $50 or decreases in value, your spread is worthless and you lose the $3500 that you paid for the spread. Second, if the stock begins to move up, you first recoup your investment and then move into profits. After the stock has moved up $3.50 you are at the breakeven point. Every money advance after that represents profit.
The chart below represents the spread’s losses and gains and your total profit
This chart is based on stock prices at expiration Friday in November. Until then the spread’s value fluctuates between $0 and its maximum (the difference between strike prices) of $10.00
At any time until expiration, you can sell out of the spread but what you receive for the price may be influenced by implied volatility and time decay and that will change your profit or loss. If you hold the spread until expiration and your bullish lean proves true, your maximum profit on your $3500 investment is $6500.
You paid $3500 for the spread and received $10,000 at expiration with the stock at $60.00. That represents a $6500 profit which is a 186% return.
If you had invested $50,000 for 1000 shares of IJK and at expiration sold the stock for $60,000, your profit is $10,000 for a 20% return.
For many investors the reward/risk scenario of the spread is attractive because investors can limit the capital at risk and the time of risk/reward exposure. The spread also offers protection if your lean is bullish or bearish. Finally, the spread has the potential of a large percentage return on investment.
By: Ron Ianieri
About the Author:
Ron Ianieri is currently Chief Options Strategist at The Options University, an educational company that teaches investors how to make consistent profits using options while limiting risk. For more information please contact The Options University at http://www.optionsuniversity.com or 866-561-8227
Filed under Investing by Administrator
October 13, 2008
The Secret of Reduced Margin Spreads
One of the best kept secrets in trading is that of reduced margin spreads. You cannot name a trading method that provides more safety or a greater return on margin than does a reduced margin spread, while also being one of the least time-consuming ways to trade. Have you ever asked yourself why it is that many of the largest, most powerful traders trade spreads? I’m going to show you why!
WHAT IS A REDUCED MARGIN SPREAD?
Because of perceived lower volatility, exchanges grant reduced margins on certain types of spreads. Spreads consist of being long in one or more contracts of one market and short in one or more contracts of the same market but in different months—an Intramarket spread; or being long in one or more contracts of one market and short one or more contracts of a different market, and in the same or different months—an Intermarket spread.
DISTORTIONS ABOUT SPREADS
There are some distortions about spread trading that need to be dispelled. If we get them out of the way, I can show you the tremendous advantages spread trading has over any other form of trading.
It is said that spreads do not move as much as outright futures. I agree 100% with that statement. However, spreads trend much more often than outright futures, they trend much more dramatically than outright futures, and they trend for longer periods of time than do the outright futures. For these reasons you can make much more money with spreads than with the outrights.
The second distortion about spread trading goes like this: “You have to pay double commissions when you trade spreads.” Yes! You have to pay two commissions for every spread you enter in the market. So what? You are trading two contracts instead of one. You pay two commissions because you are trading two separate contracts, one in one place and the other in an entirely different place. Paying two commissions for two separate trades is hardly unfair. Let me tell you what is unfair—paying a round turn commission for an option that expires worthless. Why don’t you hear people complaining about that? You pay for a round turn, and you receive only half a turn. Doesn’t make a lot of sense, does it?
ADVANTAGES OF SPREAD TRADING
There are so many advantages to trading reduced margin spreads that I hope I don’t run out of room here before I can tell you all of them. Let’s begin with return on margin, i.e., yield.
Yield: As I write this, the margin to trade an outright futures position in soybeans is $1,050, whereas a spread trade in soybeans requires only $250, only 23% as much. If soybean futures move one full point, that move is worth $50. If a soybean spread moves one full point, that move is worth $50. That means either a 5 point favorable move in soybean futures or a 5 point favorable move in a soybean spread earns the trader $250. However, the difference in return on margin is extraordinary: In the futures the return is $250/$1,050=23.8%. For the spread, the return is $250/$250=100%. Think about that!
Leverage: This leads us to the next benefit of spread trading—with the same amount of margin, you could have traded 4 soybean spreads instead of one soybean futures. How’s that for leverage? Instead of making $250 on a five point move, you could have made $1,000. Reduced margin spreads offer a much more efficient use of your margin money.
Trend: Earlier I said that spreads tend to trend much more dramatically than outright futures contracts. Not only that, but they trend more often than do outright futures. I don’t have room here to show you the dozens of sharply trending spreads that can regularly be found in the markets, so we’ll have to settle for a recent one. You’ll have to take my word for it that this sort of trending happens frequently when trading spreads.
Opportunities: Because spreads tend to trend more often and more dramatically than do outright futures contracts, they offer more opportunities for earning money, and they do so without the interference and noise caused by computerized trading, scalpers, and market movers. Spreads avoid the “noise” in the markets. There are numerous reduced margin spread opportunities, enough to keep almost any trader busy. And it is the lack of interference by market makers and shakers that leads us to one of the most important advantage of trading spreads, whether they be reduced margin or full margin.
Invisibility: One of the primary problems with any kind of trading in the outrights, whether it be in futures or stocks, is that of stop running. The insiders love it when they can see your order. Even when your entry or exit is held mentally, they know where it is. They are keenly aware of where people place their orders. That is why they love Fibonacci and Gann traders. They know precisely where those people will place their orders. The same is true for anyone who uses one of the more commonly known indicators. The insiders fade moving average crossovers, and so-called overbought and oversold—regardless of which indicator is used to show either of those conditions. They know when prices have reached the outer limits of the Bollinger Bands, and they know the location of supposed support and resistance, etc. But with spreads, they have no idea of the location of your orders. You are long in one market and short in another. Your position is invisible to the insiders. They can’t run your stop, because you don’t have one. You cannot place a stop order in the market when trading spreads! Your exit point is entirely mental; it exists exclusively in your head. In that respect, spread trading is a more pure form of trading. It is the closest thing in trading to having a level playing field. Could that be the reason you hardly ever hear about spread trading?
Liquidity: Attempting to trade in “thin” illiquid markets is one of the surest ways to encounter serious stop running and bizarre price movements. However, other than occasional problems with getting filled, spread trading does not suffer from a lack of liquidity—which in itself creates more trading opportunities. I would never consider taking an outright position in feeder cattle. Feeders are a thin, illiquid market normally best left to professional interests. But a reduced margin (feeder cattle)-(live cattle) spread is something I look for all the time. Some of the moves in this particular spread are incredible. They are worth hundreds and even thousands of dollars per spread, several times a year. They are highly seasonal in nature due to the birth and growth cycles of cattle. The same thing is true of spreading both live and feeder cattle against lean hogs. These spreads are seasonal, which brings us to the next great advantage to spread trading - seasonality.
Seasonality: Whereas seasonality doesn’t always take place as planned, i.e., seasonality can come early, late, or not at all, but when it is happening, you can see it. It is obvious when a seasonal trade is working as expected. Seasonality is not subject to the whims of man. Seasonality is one of the strongest reasons for trading spreads. Crops are planted within a given period of time. Calves and piglets are born according to their birth cycle and they grow according to their growth cycle. Even futures based on financial instruments are seasonal, and many of them offer reduced margin spreads.
Backwardation: Along with seasonality comes the huge profits that can be made when an underlying goes into backwardation. This is true for any agricultural commodity as well as any financial instrument. I don’t have space here to explain backwardation, but when it occurs, which is commonplace, the spread between front and back months widens tremendously, thereby offering marvelous profit-making opportunities to the spread trader. As if that weren’t enough, the same opportunity becomes available when the period of backwardation ends and the relationship between front and back months returns to normal.
Probabilities: If we eliminate those trades in the outrights in which you get yourself whipsawed in a sideways market and maybe win or lose a little, the actual odds of winning on any trade is 50%. If you are long and prices move down, you lose. Conversely, if you are short and prices move up, you lose. It doesn’t matter how accurate is your trade selection, the bottom line is that your chances of being right once you enter a trade are one in two. However, when you enter a spread you are not primarily concerned with the direction of prices. Your primary concern is with the direction of the spread.
With a spread you can make money when both legs of the spread are moving up, both legs are moving down, when both legs are moving sideways but one more so than the other, or best of all, when the leg you are long is moving up and the leg you are short is moving down! As long as the leg you are long is moving better than the leg you are short, you will have a winning trade. There is only one situation in which you can lose with a spread, and that is to be dead wrong about both legs. So with a spread you can win even if you were wrong about the direction of price movement, as long as you’re not too wrong.
There are additional opportunities in spread trading, including spreads that require full margin. You can trade spreads with stock indexes, sector funds, and single stock futures. Did you know you can daytrade stock index and currency spreads? These are topics for another day and another time.
Unfortunately, either by accident or design, much of the truth of spread trading has been lost over the years. There are many more aspects to it than I have touched on here. Furthermore, there are some wonderful and inexpensive tools available that make spread trading a delight. Spread trading is one of the most relaxed ways to trade. It rarely takes more than 1-2 hours of your time each day, and more often than not, we are talking about only minutes per day to seek out and trade the wonderful opportunities that are available in reduced margin spreads.
By: Joe Ross
About the Author:
WHAT IS A REDUCED MARGIN SPREAD?
Because of perceived lower volatility, exchanges grant reduced margins on certain types of spreads. Spreads consist of being long in one or more contracts of one market and short in one or more contracts of the same market but in different months—an Intramarket spread; or being long in one or more contracts of one market and short one or more contracts of a different market, and in the same or different months—an Intermarket spread.
DISTORTIONS ABOUT SPREADS
There are some distortions about spread trading that need to be dispelled. If we get them out of the way, I can show you the tremendous advantages spread trading has over any other form of trading.
It is said that spreads do not move as much as outright futures. I agree 100% with that statement. However, spreads trend much more often than outright futures, they trend much more dramatically than outright futures, and they trend for longer periods of time than do the outright futures. For these reasons you can make much more money with spreads than with the outrights.
The second distortion about spread trading goes like this: “You have to pay double commissions when you trade spreads.” Yes! You have to pay two commissions for every spread you enter in the market. So what? You are trading two contracts instead of one. You pay two commissions because you are trading two separate contracts, one in one place and the other in an entirely different place. Paying two commissions for two separate trades is hardly unfair. Let me tell you what is unfair—paying a round turn commission for an option that expires worthless. Why don’t you hear people complaining about that? You pay for a round turn, and you receive only half a turn. Doesn’t make a lot of sense, does it?
ADVANTAGES OF SPREAD TRADING
There are so many advantages to trading reduced margin spreads that I hope I don’t run out of room here before I can tell you all of them. Let’s begin with return on margin, i.e., yield.
Yield: As I write this, the margin to trade an outright futures position in soybeans is $1,050, whereas a spread trade in soybeans requires only $250, only 23% as much. If soybean futures move one full point, that move is worth $50. If a soybean spread moves one full point, that move is worth $50. That means either a 5 point favorable move in soybean futures or a 5 point favorable move in a soybean spread earns the trader $250. However, the difference in return on margin is extraordinary: In the futures the return is $250/$1,050=23.8%. For the spread, the return is $250/$250=100%. Think about that!
Leverage: This leads us to the next benefit of spread trading—with the same amount of margin, you could have traded 4 soybean spreads instead of one soybean futures. How’s that for leverage? Instead of making $250 on a five point move, you could have made $1,000. Reduced margin spreads offer a much more efficient use of your margin money.
Trend: Earlier I said that spreads tend to trend much more dramatically than outright futures contracts. Not only that, but they trend more often than do outright futures. I don’t have room here to show you the dozens of sharply trending spreads that can regularly be found in the markets, so we’ll have to settle for a recent one. You’ll have to take my word for it that this sort of trending happens frequently when trading spreads.
Opportunities: Because spreads tend to trend more often and more dramatically than do outright futures contracts, they offer more opportunities for earning money, and they do so without the interference and noise caused by computerized trading, scalpers, and market movers. Spreads avoid the “noise” in the markets. There are numerous reduced margin spread opportunities, enough to keep almost any trader busy. And it is the lack of interference by market makers and shakers that leads us to one of the most important advantage of trading spreads, whether they be reduced margin or full margin.
Invisibility: One of the primary problems with any kind of trading in the outrights, whether it be in futures or stocks, is that of stop running. The insiders love it when they can see your order. Even when your entry or exit is held mentally, they know where it is. They are keenly aware of where people place their orders. That is why they love Fibonacci and Gann traders. They know precisely where those people will place their orders. The same is true for anyone who uses one of the more commonly known indicators. The insiders fade moving average crossovers, and so-called overbought and oversold—regardless of which indicator is used to show either of those conditions. They know when prices have reached the outer limits of the Bollinger Bands, and they know the location of supposed support and resistance, etc. But with spreads, they have no idea of the location of your orders. You are long in one market and short in another. Your position is invisible to the insiders. They can’t run your stop, because you don’t have one. You cannot place a stop order in the market when trading spreads! Your exit point is entirely mental; it exists exclusively in your head. In that respect, spread trading is a more pure form of trading. It is the closest thing in trading to having a level playing field. Could that be the reason you hardly ever hear about spread trading?
Liquidity: Attempting to trade in “thin” illiquid markets is one of the surest ways to encounter serious stop running and bizarre price movements. However, other than occasional problems with getting filled, spread trading does not suffer from a lack of liquidity—which in itself creates more trading opportunities. I would never consider taking an outright position in feeder cattle. Feeders are a thin, illiquid market normally best left to professional interests. But a reduced margin (feeder cattle)-(live cattle) spread is something I look for all the time. Some of the moves in this particular spread are incredible. They are worth hundreds and even thousands of dollars per spread, several times a year. They are highly seasonal in nature due to the birth and growth cycles of cattle. The same thing is true of spreading both live and feeder cattle against lean hogs. These spreads are seasonal, which brings us to the next great advantage to spread trading - seasonality.
Seasonality: Whereas seasonality doesn’t always take place as planned, i.e., seasonality can come early, late, or not at all, but when it is happening, you can see it. It is obvious when a seasonal trade is working as expected. Seasonality is not subject to the whims of man. Seasonality is one of the strongest reasons for trading spreads. Crops are planted within a given period of time. Calves and piglets are born according to their birth cycle and they grow according to their growth cycle. Even futures based on financial instruments are seasonal, and many of them offer reduced margin spreads.
Backwardation: Along with seasonality comes the huge profits that can be made when an underlying goes into backwardation. This is true for any agricultural commodity as well as any financial instrument. I don’t have space here to explain backwardation, but when it occurs, which is commonplace, the spread between front and back months widens tremendously, thereby offering marvelous profit-making opportunities to the spread trader. As if that weren’t enough, the same opportunity becomes available when the period of backwardation ends and the relationship between front and back months returns to normal.
Probabilities: If we eliminate those trades in the outrights in which you get yourself whipsawed in a sideways market and maybe win or lose a little, the actual odds of winning on any trade is 50%. If you are long and prices move down, you lose. Conversely, if you are short and prices move up, you lose. It doesn’t matter how accurate is your trade selection, the bottom line is that your chances of being right once you enter a trade are one in two. However, when you enter a spread you are not primarily concerned with the direction of prices. Your primary concern is with the direction of the spread.
With a spread you can make money when both legs of the spread are moving up, both legs are moving down, when both legs are moving sideways but one more so than the other, or best of all, when the leg you are long is moving up and the leg you are short is moving down! As long as the leg you are long is moving better than the leg you are short, you will have a winning trade. There is only one situation in which you can lose with a spread, and that is to be dead wrong about both legs. So with a spread you can win even if you were wrong about the direction of price movement, as long as you’re not too wrong.
There are additional opportunities in spread trading, including spreads that require full margin. You can trade spreads with stock indexes, sector funds, and single stock futures. Did you know you can daytrade stock index and currency spreads? These are topics for another day and another time.
Unfortunately, either by accident or design, much of the truth of spread trading has been lost over the years. There are many more aspects to it than I have touched on here. Furthermore, there are some wonderful and inexpensive tools available that make spread trading a delight. Spread trading is one of the most relaxed ways to trade. It rarely takes more than 1-2 hours of your time each day, and more often than not, we are talking about only minutes per day to seek out and trade the wonderful opportunities that are available in reduced margin spreads.
By: Joe Ross
About the Author:
Joe Ross, trader, author, trading educator is one of the most eclectic traders in the business. His 50+ years include position trading of shares, and futures. He daytrades stock indices, currencies, and forex. He trades futures spreads and options on futures, and has written books about it all - 12 to be exact. Joe is the discoverer of The Law of Charts™, and is famous for the Ross hook™ and the Traders Trick Entry™. Trading Educators
Filed under Day Trading by Administrator
Nothing affects your profitability more than the spreads offered by your Broker. But spreads in the Forex charts spot market can be confusing to understand, and the marketing from many brokerages can be deceiving. Nearly every broker is claiming to have the tightest Forex charts and spreads in the industry. However, what does this mean, and how can you tell if a brokerage is delivering what they promise.
In order to understand the spread, you need to know what it is. A spread is the difference between the ask price (the price you buy at) and the bid price (the price you sell at) that is quoted in the pips. The pips are the smallest unit of difference between the two currencies in the quote. If the quote between EUR/USD at a given moment is 1.2222/4, then the spread equals 2 pips, the difference between the 2 and the 4. If the quote is 1.22225/4, then the spread is going to equal 1.5 pips.
The spread is how brokers make their money. Wider Forex charts and spreads will result in a higher asking price and a lower bid price. The end result of this is that you will pay more when you buy and get less when you sell, making it more difficult to realize a profit. Brokers generally don`t earn the full spread, especially when they hedge client positions. The spread helps to compensate the brokerage for the risk it assumes from the time it starts a client trade to when the broker`s net exposure is hedged (which could possibly be at a different price).
Forex charts and spreads affect the return on your trading strategy in a big way. As a trader, your sole interest is buying low and selling high (like futures and commodities trading). Wider Forex charts and spreads means buying higher and having to sell lower. A half-pip lower spread doesn`t necessarily sound like much, but it can easily mean the difference between a profitable trading strategy and one that isn`t.
The tighter the spread is the better things are going to be for you. Nevertheless, tight Forex charts and spreads are only meaningful when they are paired up with good execution. A good example of this is when your screen shows a tight spread, but your trade is filled a few pips in the wrong direction, or is mysteriously rejected.
When this occurs repeatedly, it means that your broker is showing tight Forex charts and spreads but is effectively delivering wider Forex charts and spreads. Rejected trades, delayed execution, slipping, and stop-hunting are strategies that some brokers use to get rid of the promise of tight Forex charts and spreads.
Forex charts and spreads should always be considered in conjunction with depth of book. Oddly enough, when it comes to economies of scale, Forex charts doesn`t even act like most other markets. On the inter-bank market, for example; the larger the ticket size, the larger the spread is. So when you see a 1-pip spread on an ECN platform, you have to wonder if that spread is valid for a $2M, $5M or $10M trade, which it probably isn`t. In many cases, the tight spread that is offered applies only to a capped trade sizes that don`t work for most of the common trading strategies.
Spread policies change a great deal from broker to broker, and the policies are often difficult to understand. This makes comparing brokers difficult. Some brokers actually offer fixed Forex charts and spreads that are guaranteed to remain the same regardless of market liquidity. But since fixed Forex charts and spreads are traditionally higher than average variable spreads, you can end up paying an insurance premium during most of the trading day so that you can get protection from short-term volatility.
Other brokers offer traders variable Forex charts and spreads depending on market liquidity. Forex charts and spreads are tighter when there is good market liquidity but they will widen as liquidity dries up. When it comes to choosing between fixed and variable rates, the choice depends on your individual trading pattern. If you trade primarily on news announcements that you hear, you may be better off with fixed Forex charts and spreads. But only if the quality of execution is good.
Some brokers have base the Forex charts and spreads they offer their clients on the type of account the client has. For example, those clients that have larger accounts or those who make larger trades may receive tighter Forex charts and spreads, while the clients that are referred by an introducing broker might receive wider spreads in order to cover the costs of the referral. Other brokers offer the same spreads to everyone.
It is often difficult to get information on a company`s Forex charts and spread policy or its order book depth. Because of this, many traders are caught up in the promises they hear, often take a broker`s words at face value. This can be dangerous. The only real way to find out what a company`s policy really is to try out various brokers or talk to those who have.
By: Jimmy Cox
About the Author:
In order to understand the spread, you need to know what it is. A spread is the difference between the ask price (the price you buy at) and the bid price (the price you sell at) that is quoted in the pips. The pips are the smallest unit of difference between the two currencies in the quote. If the quote between EUR/USD at a given moment is 1.2222/4, then the spread equals 2 pips, the difference between the 2 and the 4. If the quote is 1.22225/4, then the spread is going to equal 1.5 pips.
The spread is how brokers make their money. Wider Forex charts and spreads will result in a higher asking price and a lower bid price. The end result of this is that you will pay more when you buy and get less when you sell, making it more difficult to realize a profit. Brokers generally don`t earn the full spread, especially when they hedge client positions. The spread helps to compensate the brokerage for the risk it assumes from the time it starts a client trade to when the broker`s net exposure is hedged (which could possibly be at a different price).
Forex charts and spreads affect the return on your trading strategy in a big way. As a trader, your sole interest is buying low and selling high (like futures and commodities trading). Wider Forex charts and spreads means buying higher and having to sell lower. A half-pip lower spread doesn`t necessarily sound like much, but it can easily mean the difference between a profitable trading strategy and one that isn`t.
The tighter the spread is the better things are going to be for you. Nevertheless, tight Forex charts and spreads are only meaningful when they are paired up with good execution. A good example of this is when your screen shows a tight spread, but your trade is filled a few pips in the wrong direction, or is mysteriously rejected.
When this occurs repeatedly, it means that your broker is showing tight Forex charts and spreads but is effectively delivering wider Forex charts and spreads. Rejected trades, delayed execution, slipping, and stop-hunting are strategies that some brokers use to get rid of the promise of tight Forex charts and spreads.
Forex charts and spreads should always be considered in conjunction with depth of book. Oddly enough, when it comes to economies of scale, Forex charts doesn`t even act like most other markets. On the inter-bank market, for example; the larger the ticket size, the larger the spread is. So when you see a 1-pip spread on an ECN platform, you have to wonder if that spread is valid for a $2M, $5M or $10M trade, which it probably isn`t. In many cases, the tight spread that is offered applies only to a capped trade sizes that don`t work for most of the common trading strategies.
Spread policies change a great deal from broker to broker, and the policies are often difficult to understand. This makes comparing brokers difficult. Some brokers actually offer fixed Forex charts and spreads that are guaranteed to remain the same regardless of market liquidity. But since fixed Forex charts and spreads are traditionally higher than average variable spreads, you can end up paying an insurance premium during most of the trading day so that you can get protection from short-term volatility.
Other brokers offer traders variable Forex charts and spreads depending on market liquidity. Forex charts and spreads are tighter when there is good market liquidity but they will widen as liquidity dries up. When it comes to choosing between fixed and variable rates, the choice depends on your individual trading pattern. If you trade primarily on news announcements that you hear, you may be better off with fixed Forex charts and spreads. But only if the quality of execution is good.
Some brokers have base the Forex charts and spreads they offer their clients on the type of account the client has. For example, those clients that have larger accounts or those who make larger trades may receive tighter Forex charts and spreads, while the clients that are referred by an introducing broker might receive wider spreads in order to cover the costs of the referral. Other brokers offer the same spreads to everyone.
It is often difficult to get information on a company`s Forex charts and spread policy or its order book depth. Because of this, many traders are caught up in the promises they hear, often take a broker`s words at face value. This can be dangerous. The only real way to find out what a company`s policy really is to try out various brokers or talk to those who have.
By: Jimmy Cox
About the Author:
Who Else Wants To Learn A Simple, Step-By-Step System For Generating Quick & Easy Profits, Trading Forex? - FREE FOR A LIMITED TIME - http://www.forextradingstrategies.org
Filed under Finance by Administrator