In financial markets, especially in the forex market, the spread is one of the key and fundamental concepts. The spread refers to the difference between the asking price (Ask) and the bidding price (Bid) of an asset. On certain occasions, particularly during nighttime hours, the spread increases and becomes what is known as “wide.”
Reduction in Market Liquidity
A reduction in liquidity is one of the most significant reasons for the increase and widening of spreads at night. This phenomenon arises from several key factors that directly impact trading volume and market activity. Below are the primary reasons for reduced liquidity at night:
Closure of Major Financial Markets
During the night, major markets such as New York and London — which have a substantial influence on global trading volume — are closed. These markets provide a significant portion of the liquidity in financial markets. As these markets close, trading volume decreases, resulting in reduced liquidity in the market.
How does the reduced activity of major market players cause the spread to widen?
Major market players such as investment banks, financial institutions, and hedge funds usually operate during the active hours of major markets. Once these institutions close for the day, trading volume significantly decreases.
Reduction in Liquidity Providers
During the day, major liquidity providers play a crucial role in maintaining market stability and reducing spreads. When their working hours end, liquidity supply diminishes, causing spreads to widen.
Limited Activity in Smaller Markets
After the closure of major markets like New York and London, only smaller markets such as Sydney and Wellington (New Zealand) remain active. Compared to major markets, these smaller markets have lower trading volumes and cannot supply sufficient liquidity to stabilize the market effectively. As a result, spreads tend to increase during these periods.
Increased Spread Between Bid and Ask Orders
In low-liquidity conditions, the gap between buy orders (Bid) and sell orders (Ask) widens. This imbalance prompts brokers to increase spreads to compensate for the higher risk.
Closure of Major Markets
The closure of major financial markets is one of the key factors contributing to the widening of spreads at night. Major markets such as New York, London, and Frankfurt play a vital role in supplying liquidity and maintaining trading volume during the day. When these markets close, trading conditions change, and spreads increase.
Impact of Market Closures on Spreads
The European and American markets are the world’s largest financial hubs, handling a significant portion of global transactions. The high activity levels in these markets ensure ample liquidity, resulting in tighter spreads and more stable price movements. However, when these markets close:
- Trading volume drops significantly, reducing market liquidity. This reduction leads to a wider gap between the buy price (Ask) and the sell price (Bid).
- Major market players like investment banks, hedge funds, and financial institutions, which are key contributors to liquidity, become inactive during these hours.
- Markets that remain open during this period, such as the Australian and New Zealand markets, are comparatively smaller and less capable of handling large transaction volumes. Consequently, they cannot supply sufficient liquidity to stabilize the market, causing spreads to widen further.
- Besides reduced trading volume, the gap between buy and sell orders tends to increase. This widening gap prompts brokers to increase spreads to manage the risks posed by unexpected price fluctuations.
As a result, the closure of major markets leads to a significant drop in liquidity and a noticeable increase in spreads. Professional traders often avoid trading during these hours or adopt more conservative strategies to minimize potential losses resulting from the widening of spreads.
Increased Risk During Low-Volume Periods
During nighttime hours, reduced activity in financial markets leads to a significant decrease in liquidity. This reduction in liquidity is one of the key factors contributing to increased trading risk. In such conditions, the market becomes more vulnerable, resulting in sharper and more unpredictable price fluctuations. This situation can have a direct impact on the widening of spreads.
Reduced Market Depth and Its Impact on Volatility
A decrease in trading volume results in reduced market depth. In situations where market depth is low, even small-volume trades can have a substantial impact on prices. In this scenario, sudden and severe price fluctuations are more likely to occur, and prices can change rapidly.
Occurrence of Price Gaps
During this period, price gaps also occur more frequently. These gaps typically happen when there are fewer buy and sell orders in the market, causing prices to suddenly experience significant jumps. To compensate for this risk, brokers increase the spread between the buy (Ask) and sell (Bid) prices.
Risk Management Strategies During Low-Volume Periods
To minimize the negative effects of these conditions, traders can take the following steps:
- Avoid high-risk trades during low-volume market hours.
- Set appropriate stop-loss (Stop Loss) and take-profit (Take Profit) levels to prevent potential losses.
- Conduct trades during more stable periods or when major markets are open.
Impact of Economic News
Economic news is one of the most significant factors influencing financial market fluctuations. On some occasions, this news is released during nighttime hours and can cause sudden and sharp changes in asset prices. These changes occur due to the rapid reaction of investors to new information, prompting brokers to widen spreads to protect themselves from the risks associated with these unpredictable fluctuations.
Reasons for the Stronger Impact of Economic News at Night
Several factors contribute to the greater impact of economic news during nighttime hours:
Reduced Market Liquidity: During nighttime hours, liquidity is significantly lower compared to the active hours of major markets. This reduction in liquidity makes the impact of economic news on prices more intense and sudden. Under these conditions, even minor changes in order volumes can lead to significant price fluctuations.
Decreased Activity of Major Players: With the closure of major markets such as New York and London, institutional investors and key market participants become less active. This reduction in institutional presence decreases market stability, increasing emotional and rapid reactions among retail traders, which amplifies price volatility.
Market Surprises: Occasionally, unexpected economic news is released in the late hours of the day or night. Such news can alter market expectations and result in significant price swings.
Broker Actions in Response to Economic News
To mitigate the risks arising from unexpected fluctuations caused by economic news, brokers often take the following actions:
Increasing Spreads: To compensate for the heightened risk in volatile conditions, brokers widen spreads to protect themselves from potential losses.
Temporary Suspension of Certain Services: During periods of extreme volatility, some brokers may temporarily limit the execution of large orders or specific trading strategies to prevent liquidity issues.
Risk Management in Response to Economic News
To manage risks effectively during the release of economic news at night, traders can adopt the following strategies:
Follow the Economic Calendar: Monitoring the schedule of significant economic news releases can help traders avoid taking high-risk trades during these periods.
Set Stop Loss and Take Profit Orders: Using these tools allows traders to limit potential losses and secure profits in case of sudden price fluctuations.
Reduce Trade Sizes in Volatile Conditions: Lowering position sizes during major news releases can help traders minimize risks and protect their capital.
Changes in Banking and Financial Institution Hours
Banks and financial institutions play a crucial role in supplying liquidity to financial markets. These entities maintain market stability by executing large transactions and providing consistent liquidity. However, during nighttime hours, when major banks and financial institutions in key economic countries are closed, this balance is disrupted, and liquidity volumes decrease significantly.
Reduced liquidity during this period results in fewer buy and sell orders, widening the gap between the ask (buy) and bid (sell) prices. Consequently, brokers widen spreads to manage the risks associated with unexpected price fluctuations.
Additionally, the absence of major liquidity providers during nighttime hours can lead to significant price movements even with relatively small transaction volumes. This factor further contributes to the widening of spreads during these hours.
Strategies for Managing Spreads at Night
To better manage wide spreads during nighttime hours, traders can follow these tips:
One of the most effective steps is to avoid trading during volatile nighttime hours, particularly during the closure of major markets such as New York and London. The period between the New York close and the Sydney open typically experiences the lowest liquidity levels and the widest spreads.
Using trading accounts with fixed spreads can also be an effective solution. Some brokers offer fixed spread accounts that help prevent unexpected spread increases during low-volatility conditions.
Risk management during these hours is also crucial. Setting appropriate Take Profit (TP) and Stop Loss (SL) levels can help mitigate sudden losses caused by widened spreads. These measures enable traders to maintain better control over their capital even in volatile conditions.
By following these strategies and implementing effective trading practices, traders can minimize the negative impact of increased spreads during nighttime hours and ensure better trading conditions.
How to Reduce Spread?
Reducing the spread in trading can have a direct impact on lowering trading costs and increasing profitability. There are effective strategies that, when followed, can significantly reduce the spread. Below are some effective methods to reduce spread:
Choosing a Broker with Low Spreads
Selecting a reputable broker that offers low spreads is one of the most important strategies for reducing trading costs. Brokers that provide ECN (Electronic Communication Network) accounts or Straight Through Processing (STP) accounts typically offer lower spreads compared to standard accounts. These account types connect directly to liquidity providers, allowing them to provide more competitive spreads.
Trading During Peak Market Hours
Trading during periods of high liquidity can play a key role in reducing spreads. The best time to trade is when major markets like New York and London are open simultaneously. During these hours, liquidity is at its highest, and spreads are usually at their lowest.
Choosing Assets with High Liquidity
Trading in currency pairs or assets that have high liquidity can help reduce spreads. Assets such as major currency pairs (e.g., EUR/USD, GBP/USD, and USD/JPY) generally have lower spreads compared to less popular currency pairs due to their high trading volume.
Avoiding Trading During Volatile Conditions
During periods of significant market volatility, brokers often widen spreads to manage potential risks. Avoiding trades during major economic news announcements or during the closing hours of markets can help minimize spread-related costs.
Using Fixed Spread Accounts
Some brokers offer accounts with fixed spreads. These accounts can be particularly useful during periods of high market volatility, providing a stable cost structure. By choosing this type of account, your spread remains unaffected by sudden market changes.
Improving Trading Strategies
Traders can reduce their spread costs by adopting strategies that focus on larger time frames and precise entry and exit points. By avoiding frequent trades and limiting continuous spread payments, traders can effectively lower their overall costs.
Negotiating with Brokers for High-Volume Accounts
If your trading volume is high, some brokers may offer discounts on spread costs or commissions. Establishing communication with your broker and negotiating for reduced spreads can be a valuable option for professional traders.