| Spreads |
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SPREAD The spread is the difference between the price a trader buys and sells. There is a spread in all financial markets. Stocks, bonds, FX all have a price where you can buy and a different price where you can sell. The bid is the price where a trader sells and the offer is where the trader buys. These conventional names are derived from the market maker’s perspective. The dealer buys on the bid and sells on the offer. This is the built in house advantage that a dealer receives. The dealer receives this advantage as payment for the services he provides. Much information can be derived from the spread. The width of the spread can be seen as a measure of liquidity in the market. If there are many aggressive dealers in the market, then each market maker will be competing to sell at the lowest price and buy at the highest price in order to win your business. Conversely this serves the trader well as he will be able to buy at the lowest price and sell at the highest price. When spreads are wide, liquidity is lacking. Price makers are reluctant to provide a low price at which to buy and a high price at which to sell. These situations occur when surprises hit the market and participants are unsure of what is a fair price to sell and buy. This lack of liquidity generally lasts for only a few seconds after the surprise because aggressive market makers will jump into the market at good levels to win the customer business that is pent-up during the lack of liquidity. INTEREST Spot FX contracts are settled two business days from the day they are dealt. This is an Interbank convention. If a trade remains open past the 5 P.M ET end of day for the FX market, then it will be swapped to the next business day. Since you are now an owner or debtor of cash for more than an entire day, you will be paying or receiving interest on the currencies you are trading. As in any bank account, the trader will receive interest on any currency he holds (such as holding deposits in a bank account) and pay interest on any currency he has sold (such as paying interest on a loan). The interest rate that a trader will receive or pay on each currency will be the overnight interest rate on each currency. The interest rate is a freely traded rate on the Interbank interest rate market, and is closely related to central bank benchmark lending rates for each respective currency. This process occurs everyday the trade is open. On Wednesdays at 5 P.M. ET, the trade will rolled from settling on Friday to settling on Monday due to the weekend. This Wednesday end of day roll will incorporate the interest to pay and receive over the weekend. If there are any holidays, then the interest for that day will also be incorporated into the rollover. Interest earned or paid is an integral facet of FX trading as many strategies incorporate the buying of high yielding currencies and the selling of low yielding currencies. Roll rates also can be seen as a transaction cost if you are paying more interest on the currency you sold, than you are receiving on the currency you bought. LEVERAGE/MARGIN Leverage, or gearing, is the tool used in FX trading to control an asset that is much larger than your current account can support. It normally entails a deposit, the margin, of a certain percentage of the total value of the asset in order to control that asset. If the leverage a trader selects is 400:1, then for every 1 dollar of margin the trader deposits he can control 400 dollars. The margin percentage at that level of leverage is 0.25%. In order to control a USD 100,000 trade, the trader must deposit USD 250 in margin funds. If the funds on deposit in a trader’s account are no longer sufficient to maintain the USD 250 margin, then the FCM will initiate a margin call. Margin calls can entail a request for additional funds, a partial closing of open trades or a closing of all open positions so that ultimately no margin is required anymore. Each FCM has its own policies in regards to margin calls as they are the ultimate bearers of your risk. An account’s ability to fund the margin will be negatively impacted by account withdrawals, interest paid out on rollovers, and most significantly mark to market losses on open trades. Please read our Risk Disclosure on the risks involved in trading in leveraged products. |
