The Significance of the ‘Spread’ in Forex Trading – Part 2

Filed under: Learn Forex Trading |

In part 1 of this article, I explained how damaging the spread can be in forex trading, and I pointed to two things that you can do to combat the spread. These were:

 

1)    Find a reliable broker who offers low spreads

2)    Use the higher timeframes

 

When you use the higher timeframes in forex trading, you tip the odds in your favour by mitigating the effects of the spread. For example, if you trade off of the 5-minute chart, your stop losses will inevitably be tighter. You stop loss may be just 100 pips, and you risk $1 per pip on the trade with your target being 200 pips. However, with a spread of 20 pips, this will cost you $20, or 10% of your potential $200 target.

 

However, if you trade off a daily chart, your stop loss will naturally be wider. For example, your stop loss may be 1000 pips, your target 2000 pips, and this time you risk $0.10 per pip. On both trades, your risk is $100 and your target is $200. But, and this is important, on this trade, the spread is again 20 pips, but this is only $2 this time, or 1% of your target. This makes a big difference – especially if you have a high volume of trades – which you probably would if you traded off of the 5-minute chart.

 

By way of example, over the course of 1000 trades, on the daily chart, the spread might take $2000 of your profits. If you have a before spread profit of $15,000, then this will not be a problem. However, over the course of 1000 trades on the 5-minute chart, the spread may eat around $20,000 of your profits. And if your before spread profit is again $15,000, then this will be a problem. A big one.

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