Low Spread vs Low Commission: Which Saves More in Real Trading?

The forex trading is a competitive world and every pip matters to your profitability. There are two essential cost structures that are prevailing, the spread-based pricing and the commission-based model. The key distinction between these styles and how they affect your performance in the trading profession in real life is the difference between the steady earnings and the accumulation of losses. Such an in-depth discussion will make you decide which pricing model really provides superior value to your trading style and goals.

Understanding Spread-Based Trading Costs

The spread looks into the disparity between the ask and bid of a currency pair. When trading with a spread based broker this is his main source of revenue. The larger the spread, the higher is the pay in entering and leaving positions. As an example, when EUR/USD bid price is 1.1050 and the ask price is 1.1052, the spread is 2 pips and as such you already incur a 2-pip fee when transacting a position.

It is also important that traders that make a lot of transactions every day find the best low spread broker. The spreads provided by such brokers are generally lower when the market is at its best as the liquidity is high. Nevertheless, spreads may increase by a great deal in low-liquidity times, economic announcements, or market volatility, which will lead to a rise in your trading costs whose occurrence you had not planned.

The advantage of spread-based pricing is that it is simple and transparent. Your trading costs are directly displayed as your bid-ask difference, and it is easier to compute how much you will be able to realize by trading. The model is especially helpful to traders who do not want to have extra charges or complicated calculations of the prices.

Commission-Based Trading Models Explained

A commission based brokerage assumes a fixed trade fee and provides raw market spreads also commonly referred to as ECN (Electronic Communication Network) or STP (Straight Through Processing) execution. These brokers do not mark up spreads but rather make commissions that are normally levied on opening positions and closing positions. As an illustration, you can be charged 3.5 USD per standard lot of a traded deal, irrespective of the currency pair and market dynamics.

Interbank spreads are available in this model and these spreads tend to be tighter than retail spreads charged by spread-based brokers. In busier trading periods, the spreads of major pairs of currencies may fall to 0.1 to 0.3 pips, which is much less than the spreads of 1 to 2 pips in retail markets. Nevertheless, you have to include the round trip cost of commissions to compute the amount you have spent on trading.

Price commissioning is predictable and stable. Your commission is not affected by market volatility or trading session, and thus you can make even more precise profits and risk management. The stability is especially helpful to algorithmic traders and high-frequency traders with their focus on the predictability of costs.

Real-World Cost Comparison Analysis

In order to find out which pricing system helps to save more money, you should compare your trading patterns and volumes. Take a trader who is trading 100 standard lots every month in the major pairs. Once the spread-based broker has an average spread of 1.5 pipes, then the monthly cost of 150 pipes would be 1,500 USD or 150 pips given an assumption that each pip is 10 USD on the standard lots.

That trader with a commission-based broker with a round-trip commission of 7 USD per lot and average spread of 0.4 pips would incur a cost of 700 USD commission and 40 pips (400 USD) spread costs which equals 1,100 USD a month. In the given case, commission model is saving one 400 USD in a month or 4,800 USD in the year.

These calculations however can differ tremendously depending on the frequency of trade, size of position and currency pairs traded. The spreads of exotic pairs are generally wider irrespective of the type of the broker whereas the major pairs are the most competitive in both models. The competitive and best spread forex brokers have a tendency of offering the best spreads in combination with the optional commission based accounts to the high volume traders.

Trading Style Impact on Cost Efficiency

The approach to trading that you use largely determines the pricing model that is more cost effective. The cumulative impact of tight spreads is more beneficial to scalpers or day traders who are fillers of small positions. The difference in the spread, even in small quantities, is magnified very rapidly when dozens of positions are opened every day.

Position traders and swing traders who keep their trades over days or weeks will be better served by spread-based pricing. The effect of slightly broader spreads is reduced since they make fewer trades than the certainty of paying off commission fees. Also, long-term traders will have a greater ability to endure the temporary expansion of the spread in the time of turbulence.

Commission-based models are almost always beneficial to high-frequency traders and traders who use automated systems. The accuracy and predictability of the commissions cost are more consistent with algorithmic trading that trades on high frequency, small amount profits. These traders are able to compute the expected returns correctly and optimize on their plans with fixed commission costs.

Hidden Costs and Additional Considerations

In addition to spreads and commissions, both models of pricing can have concealed expenses that can affect your bottom line. Overnight swap rates, deposit and withdrawal charges, maintenance charges of the account can become hefty costs whether you are using your own pricing model or not. Other brokers that might be providing competitive spreads or commissions will cover up with increased swap rates or extra fees.

Conclusion

Low commissions do not necessarily offer better value in forex trading and neither does low spreads. The best option is determined on the basis of your frequency of trading, the size of the position that you tend, the strategy duration and the preference of individuals in terms of currencies. The higher volume traders usually get better rates with commission based models that provide raw spreads whereas the occasional traders can be pleased with the ease of spread based pricing.

In forex trading, it is necessary to look beyond marketing arguments regarding the low cost in order to know the overall trading cost in your unique situation. Through proper analysis of your trading trends and estimating the actual costs of trading under both models, you can make an informed statement that will allow you to increase your profitability and trade in a manner that meets your objectives. The trick is to seek the pricing structure which is going to supplement your strategy and allow the reliable execution and understandable cost structure.