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Look for Razor Thin Transaction Costs (Lowest Spread + Commission)

For me, and for many traders, spread should be the foremost (though not only) comparative criteria for choosing a broker. Narrowing the broker list down to a competition of spread is a fast way of eliminating 90% of the broker options. For more information on what a spread is and how it can be discovered, please read our article on Transaction Costs: Spreads and Commissions

The spread cost may seem too small compared to the profits one expects but spreads can add up very quickly. The more trades you conduct, the more the transaction costs mount up, and in the end, the difference in spread between brokers can make or break a system. A scalping system can be particularly sensitive to the spread, being only profitable if the spread is extremely low. Nevertheless, any system can be vulnerable to the spread over time; 200+ trades later in the system's life, the difference in spread can make the difference between a profitable system and one that struggles for life.

Spread should be a major consideration for every trader because it, and any commissions added to it (as in the case of an ECN broker), represent the transaction cost of making a trade, or the cost of doing business as a trader.
Transaction Cost for Non-ECN Brokers

Transaction Cost = Spread (Bid - Ask)

It is important to note that ECN brokers often offer better spreads than all other broker types, but be careful: they may have lower spreads but at the same time also charge a commission, and this commission cost must be added to the spread to discover the true transaction cost.

Transaction Cost for ECN Brokers

Transaction Cost = Spread + Commission

Sometimes this simple addition removes the once attractive, low spread ECN Broker from the spread contest. For instance, you might find an ECN broker that has a 1.5 average spread on the EUR/USD, which looks attractive, but when you discover it has a 1 pip commission on top of that, you are now dealing with a noncompetitive 2.5 "effective spread" for EUR/USD (noncompetitive with the dozens of non-ECN brokers who have an effective, average spread of less than 2 for EUR/USD). Somewhere on the broker website they publish what the commission rate is for their ECN platform, but if that figure cannot be so easily found then you need to open a demo account, conduct a 0.1 lot trade, and then see what the commission deduction amounts to in the Terminal screen (you might need to right click and add a check mark on Commissions). 

RazorTip! Transaction Cost for CashbackForex Brokers If you were to sign up with Introducing Brokers (IBs) who offer a rebate like http://www.cashbackforex.com, you would usually earn half of a pip back to your account for every trade, which would considerably lower the spread-transaction cost.

For All brokers listed with CashBackForex:
Transaction Cost = (Spread + Commission) - Cashbackforex Rebate 

Example of trading EURUSD with FXCM via Cashbackforex:
Average Spread on EURUSD (FXCM): 2.7
Cashback Rebate: 0.7 pips
Transaction Cost = 2.7 pip (spread) - 0.7 pips (rebate) = 2.0 pips

The more we collectively narrow the game down to the brokers with the lowest spread + commission, the more we encourage all brokers to lower their prices to stay competitive.

How low should we go in this game of reverse spread limbo, lowering the pole (spread) to a maximum height (upper spread threshold) in which we can safely trade without worrying about the spread tripping up our system? The upper spread threshold will depend on the currency pair, of course, and for your convenience, I have constructed a table criteria for competitive spread pricing.

The table lists the currency pair, spread + commission it should NOT be above, and the ideal average range it should be, during decent volume trading hours (3:00 am to 4:00 PM EST): 

Currency Pair Average Spread
+ Commission
NOT above
Spread +
2 Pips 1.5
3 Pips
3 Pips
USD/JPY 2 Pips 1.6
USD/CAD 3 Pips 1.8
AUD/USD 3 Pips 1.8
EUR/CHF 3 Pips 2
EUR/GBP 3 Pips 2
EUR/JPY 3 Pips 2
GBP/JPY 3.5 Pips 2.5

The rule of thumb in your process of elimination is that if the broker has average spreads higher than the threshold, avoid it. Keep in mind that these average spreads are what you should expect of a good broker today, given the advanced spread pricing technologies made available. Five years ago the expectation would be 1-2 pips higher for each of the pairs. Any broker who is not currently moving their spreads lower, below the above threshold, is either not taking advantage of the newer technologies and/or remaining greedy. Either way they are removing themselves from the competition.  

Shuffle the deck of broker options according to how close multiple pairs match the average spread ideal. Don't just look at the pair you intend to trade, such as the EUR/USD, but look at a few different pairs, just in case you see some opportunities with different pairs down the road. Use the Multi Pair Spread Monitor to see at a glance all spreads of all the currencies of your broker. If you see the many currency spreads meet the ideal, or do better, then these brokers get shuffled to the top of the list.  
Note that I mention average spread, not "as low as" and "typical" spread pricing. What is the difference? The "as low as" spreads advertised on some broker websites are virtually irrelevant and misleading, for you generally can't even get in or out at these levels. GBP/USD spread may be "as low as" 1 pip, but only for a few seconds per day. Not as misleading, but not quite so accurate either is the publication of "typical spreads". Different brokers define the "typical spread" differently, and each one should be investigated. For instance, FXCM publishes a nice looking table of typical spreads FXCM Forex Spreads for many of their currency pairs, and defines "typical spreads" as derived from the weighted average spread for the period of August 1, 2011 and August 31, 2011. While it is nice that they provide such a comprehensive spread table, and that their use of typical involves a weighted average spread for a recent month, you should not take their own publication at face value; you don't know for sure the average spread of any currency pair under current market conditions until you have measured it yourself with the help of third party spread monitor websites and indicators (listed below). Incidentally, FXCM's "typical spread" of 2.7 for EUR/USD casts it out of the competition, but it jumps back in if one were to open their FXCM account through CashBackForex and receive a 0.7 pip rebate, which would then make the effective spread for EUR/USD a more viable 2 pips (effective spread = 2.7 typical spread - 0.70 CashBackForex rebate = 2.0).

The better usage of spread is the average spread. The average spread is what brokers are allowing traders to execute orders at, taking into consideration every pip fluctuation throughout the trading day. 

Fixed spread brokers will be easier to investigate and compare because their spreads will stay more or less the same throughout the day. The problem with these brokers is that their fixed spread is often not as competitive as the best of the variable spreads brokers. They create an arbitrary fixed spread at the cost of any competitive spread advantage. Most of the fixed spread brokers have the EUR/USD spread at 3 pips, which is poor considering that there are many variable spread brokers well under an average 2 pip spread. Fixed spreads can also widen during any serious shakeout of the market (news, economic shifts or global events), and so you have to read the warning written on every broker website where you have fixed spreads.

Now that we have our spread criteria in mind, how do we find out brokers' spread for the currency pairs we want to trade? As suggested earlier, do not be fooled into thinking that it is as simple as going to the broker's own website and looking for their own published spreads. What they publish there is often irrelevant and misleading. They will publish the best spreads they possibly can, sometimes stooping to the dodgy "as low as" spread marketing scheme, but now more often publishing "typical" spreads that may or not be accurate, depending on their definition of "typical" and what time period they want to showcase.    

Tools and Websites to Easily View, Track and Compare Spreads

MT4 Indicators:

There are MT4 indicator tools out there that can be inserted on a currency chart to easily display the real-time and sometimes historical spreads of that chart’s currency pair.

Here are a few that we like: 

Indicator Descriptor
Displays Spread, Buy/Sell Swap, Volume of chart symbol. 
FXRM Spread History.ex4
Tracks current spread, max spread and plots spread history.
Multi Pair Spread Monitor.mq4
Tracks current spreads of multiple pairs.
Display Info All Pairs.ex4
Author: Hanover. Displays valuable information on multiple pairs: Pair Abbreviation [Column1], Bid Price [Column2], Ratio of Day Range to Average Daily Range (also as a %) [Column3-5], Spread ( also as % of ADR) [Column6-7], Pip Value [Column8], Buy Swap Rate[Column9], Sell Swap Rate [Column10]. 

Websites that Track and Compare Broker Spreads

There are also websites that compare different brokers' spreads, real time and historical, across a number of currency pairs, such as:

Website Descriptor
28 brokers. Live spread dashboard. Side tools: a) avg spread last 12 hrs/days for selected brokers; b) best 4 spread brokers. 
23 brokers. Live spread dashboard. Drill down into pairs: average spread history (nice!). Side tools: find best spread for session or time frame. 
21 brokers. Symbols View: Specific pair spread reporting between brokers over last week (min, avg, max -- overall and each session).
Broker View: spread reporting of selected broker for all pairs over last week (min,avg,max -- overall and each session).  

A Secondary Consideration: Look for Brokers Having a Fair and Competitive Overnight Interest Rates (or none at all!)

The broker spread (and/or commission) is the largest part of the transaction cost in forex, and so it trumps most other considerations. 

However, there is a secondary transaction cost in forex, and that is overnight interest (also called swap or rollover). 

If you hold a pair past 5 PM EST, your broker will credit or debit your account depending on the position on the pair (long or short) and the interest rate differential. If you are buying a currency with a higher interest rate than the one you are borrowing, the net differential will be positive (i.e. AUD/USD) - and you will earn funds (be credited) as a result. If you are selling a currency with a higher interest rate than the one you are borrowing, the net differential will be negative, and you will end up paying (be debited) for that rollover. The Rollover costs/credits are based on your position size, with the larger the position, the larger the cost or gain to you. 

Unfortunately, overnight interest applied to your account is not always fair: if you trade an equal number of longs to shorts and hold your positions overnight, you will discover that the negative swap is always more than the positive and this will slowly eat into your profits or add to your losses.

Moreover, not all brokers charge the same rates and some seem widely deviate from the bank rates. You have to check your broker's swap rate and compare it with others to discover if it has competitive and fair positive and negative rates. Customer Beware: I have seen brokers present a measly positive rate for being long a pair, and a whopping negative rate for being short the same pair. This should not be so. Expect to see a larger negative rate but not one that is 50% or more greater. Worst Case: I have seen brokers charge a negative rate on both the buy and sell swap when there was clearly an interest rate differential that should make one side positive and the other negative. If you see that the broker makes both the buy and sell swap negative on multiple pairs then this is a red flag of greedy, dishonest broker. 

Use the swap rate indicators below to discover and compare the rates of different brokers to see if they are competitive and fair:  

Indicator Descriptor
Displays Spread, Buy/Sell Swap, Volume of chart symbol
Display Info All Pairs.ex4
Author: Hanover. Displays valuable information on multiple pairs: Pair Abbreviation [Column1], Bid Price [Column2], Ratio of Day Range to Average Daily Range (also as a %) [Column3-5], Spread ( also as % of ADR) [Column6-7], Pip Value [Column8], Buy Swap Rate[Column9], Sell Swap Rate [Column10]. 

A picture of both these handy indicators applied to the AUDUSD chart of FXPro looks like this: 

How can you avoid paying swap rates? 

There are at least three ways you can avoid paying swap rates. 

1. Trade in Direction of Positive Interest.

You can go trade only in the direction of the currency that gives positive swap. This is generally not recommended unless trading in that specific direction has been the most favorable direction in terms of back tested and forward testing trading results. 

2. Trade only Intraday and Close Positions by 5:00 PM.

You would avoid the swap because you are in and out before rollover time. However, you should not decide to become an intraday trader because of the swap. The only reason that can make you become an intraday trader should be your strategy and your performance results rely on being intraday. Not because of the swap. 

3. Open up a Swap Free Islamic Account, Offered by Some Brokers.

This is an option offered to Muslim customers, though in reality non-Muslims frequently choose the category if offered. These particular accounts are run in full compliance with Islamic beliefs and the policy of no interest to be paid upon business transactions. If you believe you will be having many overnight transactions, you might consider opening a swap free Islamic account. If you expect to do an equal number of longs and shorts in your account and hold positions past 5:00 PM EST, then your account will accumulate an unfair negative overnight interest that will add to your transaction costs, on top of the spreads and commissions. Reason: the negative swap is always more than the positive. By asserting yourself Muslim you can avoid the accumulation of these overnight interest charges. Here is a list of Muslim friendly forex brokers: http://www.earnforex.com/muslim-forex-brokers. Personally, I think this is the best option of the three, and when I see that a broker offers this option, I eagerly take it. 

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