forex-scalping.com

What a 1.2 pip spread does to a 3 pip stop

Quick worked example, because I think a lot of new scalpers underestimate this.

You buy EURGBP at the ask. Say the bid is 0.8700 and the ask is 0.8712 in five digit terms, so the spread is 1.2 pips. Your entry is 0.87012 and you put the stop 3 pips below at 0.86982.

Long stops trigger on the bid. The bid is currently 0.8700, so price only has to drop 1.8 pips on the bid side before you're out. On a chart that shows bid prices, which is the default on MT4 and MT5, you'll see your stop hit on a move that looks like less than 2 pips.

So 40% of the stop distance is gone the moment you click. If the spread widens to 2 pips for a few seconds, which happens on crosses around the London open and after data, two thirds of the stop is spent before the market has moved at all.

The same applies to targets in reverse. A short closes at the ask, so your 3 pip target needs the bid to go 4.2 pips in your favour.

My takeaway is that a stop below about three times the typical spread isn't really a stop, it's a coin toss on spread noise. On EURGBP with 1.2 pips that puts my minimum near 3.6 pips, and I'd rather go to 5 and cut the size to match.

Good worked example. The ratio is what really matters: a 1.2 pip spread on a 3 pip stop means 40 percent of the stop is gone at entry. On a 10 pip stop the same spread is 12 percent.

For EURGBP specifically, spreads at many brokers widen in the Asian session, sometimes to 2 pips or more, when the pair is also very quiet. That's the worst combination for tight stops. We only trade it in London hours, when the spread is often 0.5 to 0.8 pips on raw accounts, and still use stops of 5 pips minimum.

If you want to see this on the chart instead of imagining it, switch on the ask line. In MT5 it's under chart properties, Show tab, Show Ask price line. On TradingView you can tick the bid and ask lines in the symbol settings. Watching both lines through the open makes it obvious how much the gap breathes, and you'll probably see moments where a short's stop could be hit by the ask while the bid candle never reached that price. Seeing the gap live a few times is more convincing than any explanation of it.

Another angle is the order type. A buy limit placed at the level means your entry is the ask touching that price, which in turn means the bid is already 1.2 pips lower. If you placed the level using the bid chart, your fill only happens once the bid trades 1.2 pips below your line. Plenty of missed fills that people blame on the broker are really this. When I set a buy limit from a bid chart, I add the typical spread to the price, or accept I'll only get filled on deeper moves.

For anyone on a standard account where the spread is all of the cost, the maths is even less kind. A typical standard account might show 1.0 to 1.5 pips on EURGBP and nothing in commission. On a raw account you might see 0.3 plus $7 a lot, so about 1 pip all in. The total is similar, but on raw the spread itself is small, so the stop is less likely to be triggered by spread widening alone. The commission is paid regardless and doesn't move your stop. On a 3 pip stop that difference is the whole point.

Last point: check how your broker's spread behaves in the exact minute you trade, not the daily average. Some pairs have tight spreads at 09:00 London and wide ones at 07:00, and the difference can be a full pip on crosses. If you log the spread at each entry for a couple of weeks, you'll know your real minimum stop for each hour, and you'll probably end up skipping some windows altogether. The log doesn't need to be fancy. Time, pair, spread in points, one line per entry. After two weeks you can average it by hour in a minute with a pivot table.

A short position closes by buying at the ask. A stop on a short therefore triggers when the ask reaches the level, not the bid. On a bid-only chart, the price never seems to touch the stop level, and yet the position is closed.

With a one pip spread, that means the stop on a short is effectively one pip tighter than it looks. On a long, the stop triggers on the bid, which is visible on the chart, so it looks right.

The asymmetry causes frustration. A trader sets a short stop just above a high, sees price fail to reach it on the chart, and is still stopped out. The cause is the spread.

The fix is placing short stops a spread's width higher than the level to be protected, or showing the ask line on the chart.

The effect grows when the spread widens, so stops on shorts are the ones most often hit by brief spread blow-outs.

Has a short stop ever triggered without the chart price touching it?