Brokers in the foreign exchange (FOREX) market are paid with the "spread". The spread is the difference between the ask and the bid price of the currency pair. Sometimes this spread widens, causing the brokers to receive more as compensation and the trader to receive less from their trading profits. Why does this happen and, furthermore, is it legal?
Can The Broker Increase The Spread At Will?
Instead of getting commissions such as stock brokers receive, retail brokers in the FOREX market receive the spread. Obviously, the wider the spread between the price at which the traders buy (ask) and the price at which they sell (bid), the more money the broker gets paid. Can a broker open the spread at will? The answer is simply yes. However, competition in the market places an important constraint on the brokers willingness to do so. A knowledgeable trader is naturally drawn to brokers with the lowest spreads, all other things being equal. After all, who wants to give up profits unnecessarily? Why pay one broker more then necessary when you can get the same services from a different broker with lower spreads?
Why Does The Spread Increase?
Certain periods more than others experience wider spreads in the FOREX. Wider spreads are especially prevalent when there is a release of a major economic news report. Some of these reports are released on a regular basis, such as the Non-farm Payroll Report (NFP). The NFP is typically released on the first Friday of every month. On occasion, it may be released on the second Friday instead. Followed by traders worldwide, this report is quite significant as it deals with the employment figures for the United States in various industrial sectors. The demand for trading certain currencies during this time is huge.
The currencies impacted most by the NFP are the three major currencies of the worldEuro, Dollar and Pound. As a general rule of economics, when the demand increases, the price also increases for the commodity being traded. Currencies are no exception. In addition to reasons of increased demand, the brokers also may be motivated to increase the spread to take advantage of a great opportunity to gain additional revenue on a regularly recurring basis. Then too, the brokers have a vested interest in minimizing their own exposure to loss in the marketplace based on positions they take from time to time.
Is It Legal To Widen Spreads?
Generally speaking, it is legal for a broker to widen its spreads at will. However, it also depends on what the broker has advertised to the trading public. In other words, if the broker has advertised that its spreads are always the same, even during major news releases, then the broker may be committing a deceptive trade practice by doing something other than what was advertised. If this is the case, then the trader may have recourse if he or she detrimentally relied on the misleading advertisement and suffered damages therefrom.
Before one jumps through this seemingly open door of justice, however, it is quite advisable to read the fine print. Pertinent provisions are usually contained in the user agreement accompanying the application for a trading account. If the broker states in its user agreement that spreads can be changed without notice in the sole discretion of the broker, then your path to the courthouse may have been short-circuited. Since the FOREX market is still generally unregulated, so much of what may seem otherwise illegal has not been fully addressed by legislation or the courts, and may not be for some time to come. Trader beware!
If you are ready to change your future by stepping into the exciting world of trading FOREX, go to http://www.winningtradersassociation.com for more information. Author Sandy Robinson, J.D. is part of the Winning Traders Association, an educational organization founded by John Beiler, President. The organization consists of a network of committed trainers and motivated traders willing to provide support to those interested in trading foreign exchange. Many of the members work from home.
Sandy Robinson, J.D., Copyright 2007