The importance of narrow spreads

By Justin LeBlang of MB Trading. There’s a constant debate raging in the FX community about which is preferred: Tight

By Justin LeBlang of MB Trading.

There’s a constant debate raging in the FX community about which is preferred: Tight spreads with commissions for the transaction or wider spreads without commissions.

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Setting aside for the moment the difference between a broker that is trading against you and what that broker’s interests might be, there are real-world considerations that apply here. For many technical traders, pricing in the FX world is very specific. When you see a Pivot point or a Gann number or a Fib Level or any other flat resistance or support number, a lot of times the larger banks will line up their liquidity at those prices. When that happens, the precision of the quotes displayed becomes very important. The extra “padding” that comes with the fixed spreads of a no-fee broker can actually cause executions to occur that should not.

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Let’s consider an example of the GBPJPY, and for the moment, let’s say that the Pivot for the day is at 133.50. Let’s also assume that price is currently under that level but heading up. If banks have sell orders lined up at 133.50 because it is the Pivot, then it is very important once that area is reached that the quotes reflect this. An STP/ECN broker should show pricing that represents this true liquidity. So for example, if there are indeed a lot of banks lined up to sell at 133.50, then the offer or ask for the GBPJPY should not lift above 133.50 until their sell orders have been taken out. That means that the quote on the GBPJPY could literally move to 133.49 by 133.50, which means that the buyers are interested up to 133.49 but not enough of them have paid 133.50 to move the price.

On the other hand, a deal desk/fixed spread broker is not showing the actual liquidity from the street. Their quotes trade in approximately the same area as the true market, but without the reality of holding in place where bank liquidity is located. That means that a deal desk broker with a 5 pip spread on the GBPJPY might show a quote of 133.48 by 133.53 despite the fact that there is a wall of sellers at the Interbank level at 133.50.

Even if you assume that a 2 pip spread plus a commission on a cross-pair like the GBPJPY is close to the same as a 5 pip spread on a fixed spread platform, the difference in the accuracy of the quote can have far-reaching implications to when you actually get in and out of trades. For example, someone in the above example looking to buy once the price broke above the Pivot could easily end up in the trade above 133.50 with a fixed spread broker, even if the supply from banks never exhausted at that price and eventually forced the price back down.

While there are many points to the discussion about the advantages and disadvantages of commission versus commission-free brokers, one of the main ones that gets overlooked the most is simple this: price accuracy. When banks compete to display their pricing, you get true-market quotes.

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