Forex for beginners: Tight spreads. High liquidity. Instant execution. What it means and why brokers focus on it

24.11.2020

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It’s commonly believed that success in currency trading comes from professionalism and luck. However, often it’s far from the truth. You should always remember that it’s not traders who buy and sell assets in Forex, but brokers, and the outcome of every transaction largely depends on them. Brokers build their strategies of operation around their own interests and needs of their clients, hence the differences in trading with various brokers. In this article, we’ll look at some of the aspects of exchange trading, and break down the most important criteria a newcomer should focus on to avoid getting involved with an unscrupulous broker.

Spreads

First, when choosing a broker, you need to pay attention to the size of the spreads offered. We already spoke about spreads here. Right now, we'll talk about why tight spreads are important.

Spread is one of the main sources of income for Forex brokers. They act as intermediaries between private traders and large financial institutions, providing traders with access to the global foreign exchange market. The spread is a fee for this access. It can vary depending on the instruments (currency pairs) and the personal interests of the company.

Obviously, the tighter the spread, the less money traders lose on the difference between buying and selling prices. Forex brokers offer a much lower difference than currency exchange offices.

For example, if an exchange office buys €1 for $1.03 and sells it for $1.15, this means that its EUR/USD spread is 0.12. If you buy and immediately sell 1 lot ($100,000) in such an exchange, you will lose $12,000, while brokers have access to the primary liquidity providers (large banks, investment funds, etc.) and their spreads usually make up just small fractions of the trade. A broker can offer the same EUR/USD pair with a $0.00005 spread, which is 2,400 times less than that of an exchange. The difference is obvious!

What does it mean for the trader? This means, you can work with large amounts of currency while only paying small commissions. That is why the size of the spread is one of the key points when choosing a broker.

What does it mean for a broker? In order to receive a stable income and, at the same time, not scare away clients with huge spreads, they need to acquire a reliable liquidity provider. Thus, we move on to the next important topic.

Liquidity

The liquidity of any asset is the level of its demand in the market. In other words, it indicates how quickly it can be sold at the market price. The asset with the highest liquidity is, of course, money, it is self-liquid.

Depending on how quickly an asset can be exchanged for money, liquidity is divided into three types: high, low, and medium. Highly liquid assets are money, stocks, bonds, short-term bank deposits. You can sell shares of global giants, such as Apple or Tesla, at the market price in a matter of seconds, while, for example, selling real estate, which is a low-liquid asset, can take a very long time.

By assessing the liquidity of assets, you can determine the liquidity of the company that owns them. The liquidity of a company, therefore, is its solvency. High liquidity protects the company from crises. The higher liquidity is, the more you can trust the company.

The broker’s income is the difference between the liquidity provider’s spread and the final spread for traders. This is why it’s so important for a broker to find a liquidity provider with the smallest spreads so that they can be increased while remaining attractive to clients. A trader should pay attention to this, because the broker’s final spread in this case is likely to be also smaller.

There are brokers who themselves act as liquidity providers in their clients without receiving liquidity from major market makers. In this case, the broker makes profits from traders who "blow" their deposits. This, of course, worries clients, since this means that the broker is interested in their failure. On the other hand, such conditions mean faster order execution, which is beneficial for those who prefer high-frequency trading. Unfortunately, some brokers actually abuse their power by providing non-market quotes to their clients. However, there is always a risk that professional traders will bankrupt a high-income broker, which can only be avoided through balanced risk management. For example, using a hybrid operation model, as we do in Grand Capital, transferring high volume clients to a larger liquidity provider, acting as a market maker for those who trade in low volumes.

Instant Execution and Market Execution

There are 2 modes of execution of trade orders in the market — Instant Execution and Market Execution. Each system has its own advantages and disadvantages.

Despite the term "Instant Execution", orders are not executed instantly in this system. In practice, it has nothing to do with the speed of order execution. It would be more appropriate to say that Instant Execution is simply a method of processing orders. The speed of execution depends entirely on the broker himself and its dealing policy. A more appropriate name for the term would be "Exact Execution". After all, if a broker works with this system, it promises to execute the order exactly at the price you have chosen, or not to execute it at all.

The market is volatile and fluid. After the trader clicks “Buy”, the broker starts processing the request and places the trade in the market. This process takes only a few seconds, but it can be enough for a significant change in price. If the price remains at the same level, the order is executed as usual. If the price has dropped, the order is executed at the original price, because this option gives the broker an additional earning opportunity, as it buys the asset at a lower price than that asked by the trader. If the price has risen, it is not profitable for the broker to buy assets at a higher price than that asked by the trader, so the order is rejected, and the trader receives a message about the price change—a requote.

Thus, with Instant Execution, a trade is executed only when the price remains the same or gets “worse” after the client clicks “Buy”. If the price increases, a requote occurs and the trade is canceled.

Advantages of Instant Execution:

  • Accuracy of execution

  • Fixed spread (especially beneficial for beginners and low budget traders)

  • In case of high volatility in the market, requotes are insignificant.

Disadvantages of Instant Execution:

  • Long wait until the order is executed;

  • Opening positions can be difficult due to slippage during strong market fluctuations.

Market Execution is a system where an order will be opened regardless of any price fluctuations after clicking “Buy”. The trader does not know exactly at what price the purchase will be made. It can be either less or more than the desired one. In this case, there is no need to be afraid of requotes, but there is a possibility of a strong price hikes and, as a consequence, significant losses. Such a system is more suitable for trading when it is not the accuracy of the entry into the market that’s important, but its very fact.

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Author: admin
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