How do you calculate the spread paid with variable spreads?

I have a question regarding figuring out the amount of spread that you pay on a forex trade, most particularly when there is a big difference in the spread between the time you enter and the time you exit the position. For example, if you were to enter a position when the market first opens when spreads are high, and close it several hours later when spreads are normal (smaller), how much have you paid?

I would have thought that the total spread paid could be calculated as:
Spread paid = (Spread paid on entry + Spread paid on exit)/2 irrespective of if you were entering a short or long position.

My reasoning is that you are buying at the ask, and selling at the bid, and the order is not important.
My assumption is that the bid and ask prices are approximately equidistant from a central, let's call it a 'market' price. If, as I am told, my broker is offering me the best bid and ask prices from about 10 banks, I would think this assumption is roughly valid.

For example, if you were to go short when the bid/ask spread was 0.9990/1.0010, the spread is 20 pips and you entered at 0.9990. I assume there is a 'market' price of 1.0000. Let's say the market is either flat or returns to the same place several hrs later. The bid/ask spread is now 0.9995/1.0005, the spread is 10 pips and you exit at 1.0005. You have paid 15 pips in spread, which is 1.0005-0.9990 or (20 + 10)/2.

Now I have just watched a video from an educational body, which says that if you are going long, the spread is taken out on entry. Therefore you must watch the spread and don't enter if it is greater than 7. But if you are going short, the spread is taken out on exit, therefore you should take no notice of it at entry, as it is only the spread when you exit that matters.

This makes no sense to me, as I am always buying the ask and selling the bid, and therefore it seems only logical that the spread at both times, regardless of the trade direction, are of importance. I cannot understand how the spread can be 'taken out' on either the entry or the exit.

Another way of looking at how ludicrous the statement from them seems, is if I was to go long, entering at the ask, with variable spreads. Suddenly there was a market announcement, and the market didn't really go anywhere, but the bid/ask spread increased dramatically due to lack of liquidity. I would be stopped out when the bid price dropped to my stop (sell market) level. Therefore, the spread amount must be important at the exit level of a long position as that alone caused the exit in this example.

Am I missing something or are do these 'forex experts' have it blatantly wrong?

Barramundi said:

I have a question regarding figuring out the amount of spread that you pay on a forex trade, most particularly when there is a big difference in the spread between the time you enter and the time you exit the position. For example, if you were to enter a position when the market first opens when spreads are high, and close it several hours later when spreads are normal (smaller), how much have you paid?

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In the end the spread that matters is the one at the time of your exit as that is the one determining where the bid or offer is when you are getting out of your trade.

Now I have just watched a video from an educational body, which says that if you are going long, the spread is taken out on entry. Therefore you must watch the spread and don't enter if it is greater than 7. But if you are going short, the spread is taken out on exit, therefore you should take no notice of it at entry, as it is only the spread when you exit that matters.

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Whoever did that video is apparently clueless. As soon as you open any trade the market-to-market value of your position reflects your exit price based on the current bid or offer immediately.

Rhody Trader said:

In the end the spread that matters is the one at the time of your exit as that is the one determining where the bid or offer is when you are getting out of your trade.

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Assuming the spread at the time of exit is constant, is it not true that if you have paid a high spread at entry, then the market must move further in your favour to overcome that spread than if the spread was small at entry? Therefore the spread must be taken into consideration at both the time of entry and exit, no?

Rhody Trader said:

Whoever did that video is apparently clueless.

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That was never in any doubt.

Rhody Trader said:

As soon as you open any trade the marked-to-market value of your position reflects your exit price based on the current bid or offer immediately.

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True, but if you have paid a high entry price due to a high spread, the marked-to-market value of the position willl be less than it would have been if the spread was tighter on entry, no?

I have now been told by various people that the spread is taken out on entry, that the spread is taken on exit, that it depends on the trade direction as to whether it is taken out at entry or exit, while I maintain that the spread at both entry and exit determine the total spread. This is beginning to feel like one of those road laws that everyone has a different opinion on!

Barramundi said:

Assuming the spread at the time of exit is constant, is it not true that if you have paid a high spread at entry, then the market must move further in your favour to overcome that spread than if the spread was small at entry?

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The market doesn't have to move necessarily. Assuming the spread is equal distance from the "market price" as you stated then the spread just has to contract back to normal and your mark to market value will be looking better.

You are correct in saying that there is really no right or wrong here only opinions (some stupid, but thats for another day). The way I see it, if you enter while the spread is abnormally high then you need to look only at the exit spread because at some point you know the spread will contract back to its normal range. The opposite is true if you enter while the spread is unusually small, because if it reverts back to normal prior to your exit it will cost you that extra distance. This goes against what a lots of professionals will tell you when they say get in while the spread is low.

Just my 2 cents.

Happy Trading,

Peter

BTW...during market moving events, don't believe that the widened spread is equal distance...it isn't.

Peter

wackypete2 said:

BTW...during market moving events, don't believe that the widened spread is equal distance...it isn't.

Peter

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Yes, that was a bad example, it could be all over the shop.

It sounds like you agree with my view that the spread on both entry and exit should be taken into consideration. Perhaps I should start a poll....

Barramundi said:

Yes, that was a bad example, it could be all over the shop.

It sounds like you agree with my view that the spread on both entry and exit should be taken into consideration. Perhaps I should start a poll....

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yes, just makes more sense that way.

Peter

Barramundi said:

I have now been told by various people that the spread is taken out on entry, that the spread is taken on exit, that it depends on the trade direction as to whether it is taken out at entry or exit, while I maintain that the spread at both entry and exit determine the total spread. This is beginning to feel like one of those road laws that everyone has a different opinion on!

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You're right to say that your profitability in the end is determined by the market spread at both entry and exit because the former influences where you get in and the latter where you get out. If you're doing system testing then it makes sense to try to approximate entry and/or exit spreads (depending on whether you're using big, mid, or ask prices) to guage performance.

The question of when the spread comes out of your account equity when you make a trade, though, is absolute. It happens at entry because it's a function of mark-to-market accounting. If you go long the value of your position is based on an exit at the bid. Unless you were able to buy at the bid, that means your position is immediately valued lower than your entry price as soon as you initiate it. And of course you flip that around for a short. Of course, after that things will change as the markets move and the spread changes, but the immediate situation is that the spread has gone against you and reduced the value of your position.

Thank you John. I think we are all in agreement now. I'll just have to educate the fellow that posted the video to thousands of his clients!

Barramundi said:

Thank you John. I think we are all in agreement now. I'll just have to educate the fellow that posted the video to thousands of his clients!

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Good luck with that!

Peter

wackypete2 said:

Good luck with that!

Peter

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Hmmm....thanks Pete.

I am all too aware that this guy cares more about keeping intact his ego & his image as a 'trading guru' than the account balance of his clients, as he derives his income from the sales of his 'training program'.

He is giving a lesson on the particular trade that this spread issue is of most concern on Monday. I will educate him before hand to give him a chance to take note, so he can record and distribute an amended version. If he fails to take heed, then he deserves to be publicly humiliated. And I will take delight in doing so.