Nick Goold
When you trade forex, one of the first costs you pay is the spread — the gap between the buy (ask) and sell (bid) price. Spreads are not random numbers. They are carefully set by brokers based on their business model, technology, liquidity providers, and market conditions.
Understanding how brokers set their spreads helps you compare trading costs, choose the right broker, and plan your trades more effectively.
Understanding Broker Business Models
Market Makers (Dealing Desk Brokers)
Market makers create their own internal market by taking the opposite side of your trades. For example, when you buy EUR/USD, the broker sells it to you from their inventory.
How they set spreads:
- Base prices on interbank rates but add a markup
- Often provide fixed spreads for stability
- May widen spreads during extreme volatility
Spread characteristics:
- Typically wider than ECN spreads
- Predictable, as they remain constant most of the time
- All costs included in the spread (no commissions)
ECN/STP Brokers (Electronic Communication Network)
ECN brokers give traders direct access to the interbank market by aggregating quotes from banks and institutions.
How they set spreads:
- Show the best bid and ask prices available
- Sometimes add a small markup (often 0.1–0.5 pips)
- Charge commissions (e.g., $3–7 per lot)
Spread characteristics:
- Variable and reflect real market conditions
- Very tight during high liquidity
- Can widen sharply during news events
The Mechanics of Spread Setting
Liquidity Providers
Brokers rely on liquidity providers (LPs) for actual prices:
- Tier 1 LPs: Major banks like JP Morgan or Goldman Sachs — offer the tightest spreads but require high volume.
- Tier 2/3 LPs: Smaller banks or hedge funds — provide good liquidity but often add their own markup.
Price Aggregation
Brokers use algorithms to:
- Gather prices from multiple LPs
- Select the best bid and ask
- Add their markup
- Adjust for risk exposure
- Send final prices to trading platforms
Technology Matters
- Low latency connections = faster quotes and tighter spreads
- Server location near financial hubs = better execution
- Redundant infrastructure = stable pricing even during volatility
Factors That Influence Spreads
Market Conditions
- High liquidity (e.g., London–New York overlap) = tighter spreads
- Low liquidity (e.g., between NY close and Asia open) = wider spreads
Volatility
- Calm markets = normal spreads
- High-impact news (NFP, rate decisions) = spreads can widen 200–500%
Client Segmentation
- High-volume or VIP clients often get tighter spreads
- Retail clients typically see standard pricing
Risk Management
Brokers monitor exposure; if they have too much risk in one direction, they may widen spreads to balance it.
Why Spreads Matters for Traders
Spreads might seem like just a small number on your trading platform, but they have a big influence on your results. Here’s why they matter:
Your Profit Margin
Every trade begins with a cost equal to the spread. The wider the spread, the harder it is to reach breakeven. Traders working with small targets — especially scalpers — feel this the most.
Market Access Quality
Spreads also reflect the quality of the broker’s pricing. Tight, consistent spreads usually mean the broker has strong connections to liquidity providers and efficient technology. Wide or unstable spreads can signal poor execution or hidden costs.
Risk During Volatility
When news breaks or volatility spikes, spreads can widen dramatically. If you don’t account for this, stop-losses can get hit faster and profits can shrink. Smart traders time their entries with spreads in mind.
Matching to Trading Style
Different traders experience spreads differently:
- Scalpers need the tightest spreads possible.
- Day traders still care, since costs add up quickly over multiple trades.
- Swing traders are less affected by small spread differences, but exotic pairs with wide spreads can reduce profitability.
What Traders Should Watch For in Broker Spreads
Spreads may look small, but they are a key part of your trading costs. Brokers set spreads based on liquidity, volatility, their business model, and technology. By understanding how spreads are created and why they change, you can choose the right broker, time your trades better, and adapt your strategy to reduce costs.
At the same time, traders should watch for warning signs:
- Spreads that widen without market justification
- Quotes that differ noticeably from global market prices
- “Zero spread” accounts that hide higher costs in commissions or fees
The cheapest spread isn’t always the best deal. Execution quality, regulation, and transparency matter just as much. The best broker is one that offers consistent, fair spreads aligned with your trading style — giving you the stability you need for long-term success in forex trading.
