In case you were wondering why your trading strategy fails to produce the same performance in a prop trading account as it does when you test it, chances are that the spread has something to do with this.
The reason might be easy to miss because when we think about trading strategies, we typically pay attention to entries, exits, and other aspects of our plans, but the spread remains. It always exists and affects your trading decisions and outcomes, especially in case of strict prop trading.
So let’s get things straight and find out how to make your trading strategy benefit from it.
What is Spread?
Many people ask this question: what is a spread in trading?
Spread is what you will be facing as soon as you open your position.
Though it may not look like another expense that you incur, it is still a cost that must be paid for entering the market.
Here is an example to make it easier to understand what exactly spread is:
Buying Price = Ask: 1.2000
Selling Price = Bid: 1.1998
As you can see, the 2-pip distance is the cost you pay for opening the position.
Why This Hits Harder in Prop Firm Accounts
Spreads will impact your earnings from a regular trading account. Spreads will influence your rules in a prop account.
But the rules are tough.
Typically, most prop firms will have such constraints as:
- Max loss in one day
- Total maximum drawdown
- Specific profit targets
Then let’s consider executing several trades within a day. Each trade incurs a little loss in the form of spreads. Now add them all up. You will be losing your drawdown just like that.
This explains why some people find it frustrating when they feel like they’re “doing everything right.”
The Compounding Effect of Spread
That’s when things become really interesting.
Spread not only influences one trade but also builds up through time.
For example, let’s assume you:
- Trade 10 trades per day
- The average spread is 2 pips
Then it means you incur costs for spreads at 20 pips per day
During a 5-day trading week, this becomes 100 pips
How much do you think your potential profit in such a case in your prop firm’s contest is?
Spreads Against Your Risk to Reward Ratio
This is often an underappreciated issue by many traders.
Let’s imagine your setup is:
- Stop loss is 10 pips
- Take profit is 15 pips
It seems like a decent 1:1.5 risk/reward ratio.
However, given a spread of 2 pips, your numbers are likely to be closer to:
- Real stop loss slightly narrower
- Real take profit reduced
In other words, you reduce the reward but keep your risks relatively unchanged.
Mid-Article Insight
Most traders pay too much attention to their trading strategies and ignore the importance of executing trades successfully. Once you learn that a good understanding of spreads is necessary to earn more profit, you will definitely have an eye for opportunities.
Not only do you have to find the right moment to enter, but you should be ready for any changes in market conditions. The problem may arise once you attempt to pass a challenge for the best prop firm, because each inefficiency costs the trade.
When Spreads Pose Greater Threats
Spreads vary based on current market conditions, which means that at certain points, they can influence your performance significantly.
Significant Economic News Release
The spread can easily expand during this time, causing the conditions to change rapidly.
Low Market Liquidity
In these periods, spreads are larger due to low trading volumes.
Market Opening/Closing
The fluctuations of spreads are likely during market opening/closing.
If you are unfamiliar with such situations, you may not even know that these circumstances affect the quality of your trades negatively.
Different Trading Styles, Different Impact
But the experience of spread is not identical for all traders.
Scalpers
Here, spread will be felt the hardest. Given that you are trying to profit from the smallest price changes, even a small spread like 1-2 pips may become rather burdensome.
Intraday Traders
The effect will still be felt, even if you place only a few orders during the trading session.
Swing Traders
Here, the importance of spread decreases significantly, but not becomes irrelevant.
Practical Ways to Reduce the Impact of Spread
You can’t get rid of spreads, but you can control them.
Like so:
Trade During High-Volume Periods
Liquidity is often high at London and New York times, giving tighter spreads.
Limit Yourself to Major Currency Pairs
Such pairs as EUR/USD or GBP/USD have generally smaller spreads than other, more exotic currency pairs.
Never Trade During News Announcements (unless you trade news)
Trading during announcements can be highly dangerous. Stay clear unless you have an announcement-trading strategy.
Adjust Your Targets
If spreads are somewhat bigger, try targeting slightly larger price movements.
Be Aware of Prop Firm’s Characteristics
There are various conditions on each broker. It’s important to understand them prior to trading live by testing your evaluation account thoroughly.
The Backtesting Trap
Traders conduct tests on clear chart data without considering the effects of spread.
Every trade seems profitable until the real test comes into play. Suddenly, take profits are not met, or stop losses are hit. This is because spread, slippage, and other trading factors are not considered during testing.
For accuracy, spread needs to be accounted for in any testing.
Conclusion
Although spread may seem like an insignificant matter, it is always present in prop firm trading.
It impacts entry, exit, risk-reward, and compliance with the firm’s guidelines. Successful traders do not only depend on their technical analysis; they also consider the realities of trading costs like spread.
In conclusion, when you place a trade, remember the conditions under which it is placed.
Sometimes, the solution to your trading problems does not lie in your strategy but in recognizing the small details that affect your trades.
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