Spreads are an important aspect of effective forex trading. Many intriguing concerns occur when we compare the average spread to the average daily movement. To begin, certain pairings are more profitable to trade than others. Second, retail spreads are far more difficult to overcome in short-term trading than many people believe. Third, a wider spread does not always imply that the pair is less suitable for day trading than lesser spread options. The same is true for a smaller spread—it is not always preferable to trade across a wider spread.
- Some pairings are better than others for day trading spreads, and making inferences about tradeability solely on spread size (big vs. tiny) is not effective.
- When the spread is converted into a percentage of the daily range, traders may assess which pair provides the most value in terms of spread to daily pip potential.
- Day traders will most likely trade the pairings with the lowest spread as a percentage of maximum pip potential.
- Traders may examine daily average movements to determine if trading during low volatility periods offers enough profit potential to justify active trading (with a spread).
Establishing a Baseline
A baseline is required to understand what we are working with and which pairings are better suited to day trading. The spread is translated to a percentage of the daily range for this purpose. This enables us to compare spreads to the highest pip possibilities for a day trade in that specific pair. While the statistics below represent the values in effect at the time, the test may be used at any time to determine which currency pair offers the greatest value in terms of spread to daily pip potential. The test may also be used over longer or shorter time periods.
As of November 2021, these are the daily values and estimated spreads (spreads may vary per broker). As daily average movements fluctuate, so does the proportion of daily movement represented by the spread. The proportion will vary if the spread changes.
Please keep in mind that the spread has been subtracted from the daily average range in the percentage calculation. This is to indicate that retail consumers are unable to purchase at the lowest daily bid price shown on their charts.
|Major Currency Pair Average Spreads|
|Currency Pair||Average Spread|
Which Pairs to Trade
When represented as a percentage of the daily average change, the spread may be fairly substantial and have a considerable influence on day-trading methods. This is sometimes ignored by traders who believe they are trading for free since there are no commissions.
If a trader is aggressively day trading and focuses on a certain pair, they would almost certainly trade pairings with the lowest spread as a proportion of maximum pip potential. The EUR/USD and GBP/USD have the best ratios among the pairings examined above. Among the pairings studied, the USD/JPY scores highly. Despite having a four-pip spread, the GBP/USD and EUR/JPY outperform the USD/CAD, which has an average spread of two pip. In reality, the USD/CAD trade has a spread that accounts for a larger share of the daily average range. Pairs like this are better suited to longer-term movements, as the spread becomes less meaningful as the pair travels farther.
Adding Some Realism
The calculations above assumed that the daily range is captureable, which is exceedingly improbable. Simply by chance given the EUR/typical USD’s daily range, there is less than a 1% probability of correctly predicting the high and low. Regardless of what others believe of their trading ability, even a seasoned day trader will struggle to catch a whole day’s range—and they don’t have to.
As a result, we must add some realism to our computation to account for the reality that identifying the precise high and low is exceedingly rare. Assuming a trader is unlikely to exit/enter in the top 10% of the average daily range and unlikely to exit/enter in the bottom 10% of the average daily range, this indicates a trader has access to 80% of the range. Entering and departing inside this range is more realistic than entering directly into a daily high or low.
Using 80% of the average daily range in the computation yields the following currency pair values. These figures present a picture in which the spread is considerable. With the exception of the EUR/USD, which is slightly under, the spread consumes more than 4% of the daily range. When considering the likelihood that the trader will not be able to precisely choose entries/exits within 10% of the high and low that sets the daily range, the spread in certain pairings is a considerable amount of the daily range.
The Bottom Line
Traders should be aware that the spread accounts for a large amount of the daily average range in many pairings. When entrance and exit prices are included, the disparity gets considerably wider. Traders, particularly those who trade on short time frames, might analyze daily average movements to determine if trading during low volatility periods offers enough profit potential to make active trading (with a spread) desirable.
The EUR/USD and GBP/USD have the lowest spread-to-movement ratios, according to the statistics, but traders must refresh the information at regular intervals to identify which pairs are worth trading compared to their spread and which are not. Statistics fluctuate with time, and the spread becomes less relevant during periods of high volatility. It is critical to keep track of data and recognize when it is worthwhile to trade and when it is not.
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