News Trading Guide Series 1 - How Spreads Affect News Trading Results

News Trading can be very lucrative if you know how to trade the news effectively. Unfortunately the size of a spread is a known challenge in Forex trading, and can be much worse in news trading due to the extreme volatility involved, and pranks played by some brokers.

I have tried virtually all kinds of trading systems/strategies, and based from my experience, news tradings seems to be very consistent, and highly profitable. See our news trading weekly report

In this series we will be looking out how spreads affect news trading results. 

What is a Spread?

A spread is the difference between the BID Price and the ASK Price or the difference of pips between the bidding price and the asking price.

How do I know the amount of spread I'm paying?

Spread values being advertised by some brokers do not match with what is obtainable on the trading platforms all the time. So it is important you know how much you pay your broker from spreads.

It is important you understand how spreads are calculated since we have Two (2) pricing digits in Forex namely the 2/4 pricing digits, and 3/5 pricing digits also called 5th Decimal. In the 2/4 pricing digits, the Yen pairs have 2 digits after the decimal e.g. 120.25 while the 3/5 have 3 digits after the decimal e.g 120.254. Other pairs in the 2/4 pricing digits have 4 digits after the decimal, while the 3/5 have 5 digits after the decimal. In the 3/5 pricing digits, the last digit is a fraction and it is only added as a single digit when it is bigger than 5. So subtracting the bidding from the asking price tells you how much you are paying as spread. Secondly you can use the Crosshair tool on the MT4 line studies menu to know the amount of spread. Make sure your chart is configured to show Ask Line as the bidding line is enabled by default. Click on the Crosshair and place it on the bidding line and drag it to the asking line while holding down the mouse and a display of the difference between both lines in pip value will show. The middle value is the spread.

Using Crosshairs to detect spread value - CLICK TO ENLARGE

Also there are many third party free indicators that can display the real time amount of spread on your chart.

Who Benefits From Spread?

Spreads are beneficial to brokers ONLY. Brokers make their money from spreads. For example a broker might receive or pay for the price of EURUSD from their liquidity provider at 1.2000 and sell to their clients at 1.2002 (2 pip spread). Apart from spreads, brokers make their profits through commissions, administrative fees like deposit/withdrawal fees and also from swap deals. There are other means by which brokers make their profits apart from spreads.

Some Liquidity Providers:  Boston Prime, Morgan Stanley, SMBC, UBS, BNP PARIBAS, Bank of America, Goldman Sachs, JPMorgan Chase, LMAX, Saxo Bank, FXCM, MBTrading, Citi, SBI, GKGOH, FCStone,  Lucid Markets, ADS Securities, ABN Amro, BNP, Nomura, GSA Capital..... Some of these institutions are middlemen and intermediaries

What are the Standard Spread Values?

Spread values differ according to broker operational status such as ECN, STP, Market Maker, Currenex, & custom account types, e.t.c. There is no central authority that regulates or determine the value of spreads.

Why do spread increase arbitrarily?

Most brokers attribute the increase of spreads to the following factors:

1. Daily bank rollover from 23:55 to 00:05 server time. In case of inadequate liquidity/spreads during bank rollover, widened spreads and excessive slippage may occur.
2. High surge and demand for price feed from liquidity providers during extreme market movement, volatility and high volume orders during news release trigger spread widening. 
3. In some cases spreads are widened during Asian Sessions.

 How Spreads Affect News Trading Results

CLICK TO ENLARGE

When a trader buys GBPCAD at the displayed price above, the profit/loss displayed on the chart immediately shows a negative figure because the cost of the spread is added to the price, and deducted from the profit/loss displayed on the trading platform. In the scenario above the spread is approximately 4pips (5 digit pricing), and not 46pips. The illustration above was taken from a normal or quiet market situation. But during news releases, spreads are widened for various reasons by brokers. While some reasons being stated by some brokers are understandable others are way out of abnormal.

Prior to news releases, the market is charged up due to excessive anxiety, fear, uncertainty on the outcome of an economic decision with the capacity to send shocks to the financial market. During this period liquidity providers are on their toes trying to ensure adequate provision of liquidity or total shutdown should in case the worst scenario occur. The participants in news trading can be very massive and qualitative. All sectors of the financial market (stocks, futures, e.t.c.) are involved because of the spiral effect of the outcome of a news release most especially GDP, Interest rates, and Central Bank decisions and speeches. Unfortunately some brokers take advantage of this situation to widen their spread beyond normal as they too expect to gain from this action.

Top brokers, financial institutions as well as liquidity providers were seriously affected to the extent of bankruptcy during the recent Swiss Franc Capping Episode in January, 2015.

When spreads are widened beyond normal the cost is transferred to traders. Even when a trader enters a trade at a good fill but a bad spread he/she will need to make extra extra profits to cover the spread cost before counting his/her profit on the trade. It becomes worse when the trade goes against the trader. For example if a trader buys GBPUSD at 1.2000, and the spread widens to 5 or 6 pips instead of the normal 2.3 pips then that means the trader got into the market at 1.2006. The trader would need to make 1.2012 to get 1 pip profit. This is aside the cost of the pip value, order volume and other components that will determine the final profit/loss. So this is why your broker matters a lot when it comes to news trading.

Is there a way out?

Yes. Inform your broker about the spread issues especially if it occurs more often without any good reason. Like i said earlier, spread widening during news release is normal to an extent but when it's excessive then you should complain to your broker otherwise it's time to switch broker.  

Another method is to develop trading strategies that avoids high spreads during some sessions or accommodates it into its logic. For example our news trading strategy was developed to maximize profits even when spreads are high so we do not usually feel the effects of high spreads during news release.

So do yourself some good by checking the advertised spread values on your broker's website against the values on your trading platform.

In news trading your broker matters a lot. FXTradeCity recommends HotForex Zero Spread Account (specially designed for news trading and scalpers)

Further Guide
How I Trade The News Part-1, Part-2, Part-3