Tuesday, September 1, 2009

what make EUR/USD FX bid/ask spread so tight

- Factor: large lot size. In interbank market, each deal is around 10-100 mio USD (minimum 1 mio), so a 1 pip bid/ask spread means $1k - 10k. I believe (personal opinion) the larger the volume, the tighter the spread.

- Factor: volatility. The more volatile, the wider the spread from a given market-maker.

- Factor: market depth. A deeper market makes it "cheaper" to unwind a losing position, thereby minimizing the market maker risk. MM can therefore take more risk and provide tighter spread.

- Factor: credit risk seems to be the most important determinant of bid/ask spread. The best spread is given to the highest credit banks. http://www.investopedia.com/articles/forex/06/interbank.asp says -- "The interbank market is a credit-approved system in which banks trade based solely on the credit relationships they have established with one another. All of the banks can see the best market rates currently available; however, each bank must have a specific credit relationship with another bank in order to trade at the rates being offered. The bigger the banks, the more credit relationships they can have and the better pricing they will be able access. The same is true for clients such as retail forex brokers. The larger the retail forex broker in terms of capital available, the more favorable pricing it can get from the interbank market. If a client or even a bank is small, it is restricted to dealing with only a select number of larger banks and tends to get less favorable pricing.

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