Spreads

Importance of checking the spread

I cannot stress enough how important it is to check what the spread is before entering positions – especially for scalping or low pip target strategies. This took me a while to learn, but it is now mandatory in all my strategies and I never forget to include it, even in prototyping because it can impact the results so much.

Just yesterday I was reading through some notes on Gap trading, and one of the key indicators of a gap is an apparent lack of volume. Now, we all should know by now that we do not really have the luxury of real-time volume in Forex so any kind of volume based strategy from the equity world cannot be translated into Forex. However, we do have tick volume, and I think in certain cases I think we can still use this.

If the market was highly active, we definitely should have a large amount of price traffic. If there is a significant change in price without an appropriate level of price traffic, then this could be interpreted as a gap. I thought I would test this out briefly so I quickly whipped together an indicator – VOLUMEPRICE – that showed me when the change in price was proportionally high compared the tick volume of the bar.

I then put together a quick strategy – GAPBARSTRATEGY – to leverage this indicator, and lucky for me the start of the week for EUR/USD had some good gap opportunities.

Backtesting this strategy today showed that it didn’t trade when there were three possible signals. The screenshot below shows the spikes in the VOLUMEPRICE indicator, but my strategy didn’t trade.

GapBarStrategy

According to my logs, the spread was too high.

2014/04/27 15:14:00 Spread is 0.00147 which exceeds SpreadLimit: 0.00020
2014/04/27 15:27:00 Spread is 0.00142 which exceeds SpreadLimit: 0.00020
2014/04/27 16:26:00 Spread is 0.00171 which exceeds SpreadLimit: 0.00020

14.7 pips… 14.2 pips… 17.1 pips these are HUGE spreads. In fact, those gaps were purely caused by the spread widening. Why would you ever trade into that? Spread-checking saves the day here.

Always add spread-checking capabilities into your strategies. Depending on the type of strategy you have, it might be better off to hold on to the trading signal and trade again later.

Posted in Research, Strategies and tagged , , , .

Leave a Reply

Your email address will not be published. Required fields are marked *