1 May 2024 - 10min Read

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What is a spread in trading?

The spread in trading refers to the difference between the ask (buy) and bid (sell) prices of any financial asset, whether forex, stocks, or commodities. It also doesn’t matter whether you’re trading CFDs or spread betting; the spread is always present.

The spread can be seen as compensation for the broker to execute the specific trade on your behalf.

The spread is determined based on various factors such as supply and demand, trading volume, liquidity, and volatility. As these levels change, so will the price of an asset, which will make the spread wider or tighter.

In this article, we’ll go into more detail regarding what a spread is, how it works, and how to calculate it. We will also provide you with two different types of spreads you could find in trading.

TABLE OF CONTENTS

Key takeaways

  • The spread is the difference between a financial asset’s ask (buy) and bid (sell) price.
  • The spread can also be called the bid-ask spread.
  • The spread is prevalent in derivative products such as spread betting and CFD trading.
  • Spreads can be tight or wide depending on various factors such as supply and demand, trading volume, liquidity, and volatility.
  • There are two types of spreads available: fixed and variable.
  • The spread is the transaction cost that allows the broker to execute a trade on a trader’s behalf.

Marc Aucamp

Content Writer

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What does spread mean?

In derivative trading, such as spread betting or CFDs, the spread plays a key role as it is the difference between the ask (buy) and bid (sell) price of an asset, where the ask (buy) price will always be higher than the bid (sell) price.

This is prevalent whether you’re trading forex, indices, or commodities.

It’s also known as the bid-ask spread.

The spread can either be tight or wide. One way to define if a spread is tight or wide will depend on an asset’s trading volume. 

If there are many market participants for the specific asset who also agree on the buy and sell price, the trading volume will be high, which transfers over to a tighter spread. Consequently, if there aren’t many market participants who also don’t entirely agree on the buy and sell price, the trading volume will be lower, which means the spread will be wider.

Trading volume is just one of the factors which could influence the spread; we’ll take a look at some more factors in the next section.

There is also the situation where different financial markets will have different spreads; for example, in forex, the spreads will usually be tighter than in commodities such as gold or oil.

The spread isn’t necessarily just for the difference between the bid and ask price; it can also refer to a strategy used in options trading. This is where an individual might buy and sell a number of options containing different prices and expiration dates.

What is spread in trading

How does the spread work in trading?

The spread is used when analysing the trading cost of an asset. The spread is also directly affected by the asset’s value, in other words, the supply and demand.

When the demand for an asset is high, but the supply is low, it will increase the value of an asset. Whereas if the supply is high but the demand is low, the value of an asset will decrease.

This goes hand-in-hand with other factors that could influence the value, bid and ask price, and ultimately, the spread itself.

These factors include:

  • Volume: The volume is used to indicate the quantity of a certain asset being traded on a daily basis. When the volume is high, there are many market participants, resulting in tighter spreads. Now, when the volume is low, the spreads will usually be wider because there are fewer market participants.
  • Volatility: This is used to indicate how often the price of an asset changes over a specific period of time, such as a day or week. When the volatility of an asset is high, which means the price changes are more rapid, the spread will normally be wider. However, the spread will usually be tighter when the volatility is low.
  • Liquidity: This indicates how quickly and easily an asset is being bought or sold. If the liquidity level of an asset is higher, it usually results in tighter spreads. Whereas if the liquidity is lower, it usually results in wider spreads.

It is also common practice for most brokers and market makers to add their own transactional costs towards the spread in order to streamline the transaction process.

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How do you calculate the spread?

When using Trade Nations’ proprietary trading platform, the spread will automatically be calculated for all assets. However, knowing how the spread is calculated might still be helpful.

In order to calculate the spread, you’ll take the ask (buy) price and subtract it from the bid (sell) price. This will give you the spread value in pips.

Calculating spread in pips

To better understand how this will look when trading, we’ll look at some examples in the next section.

Example of spreads when trading

Now that you have a better understanding of how to calculate an asset’s spread let’s look at two examples: one of a tight spread and one of a wide spread. 

First, we will look at an example of a tight spread.

Let’s say you’re looking at a forex pair such as GBP/USD, which is trading with an asking price of 1.2359 and a bid price of 1.2357; you’ll subtract 1.2359 from 1.2357 (1.2359 – 1.2357) giving you a spread of 0.0002 or 2 pips.

Now, let’s look at an example of a wide spread.

Next, we’re going to use another forex pair. However, we will use one with a lower level of liquidity, such as EUR/TRY (Euro against the Turkish Lira).

Let’s say EUR/TRY is trading at an asking price of 30.5538 and a bid price of 30.5513. Again, we’ll subtract the asking price from the bid price, 30.5538 – 30.5513, which gives a spread of 0.0022 or 22 pips.

What are the different types of spreads?

Two different types of spreads are available depending on your chosen broker.

These are:

  • Fixed
  • Variables

Let’s take a more detailed look into these two types of spreads.

What are fixed spreads?

Fixed spreads always stay the same; it doesn’t matter how volatile the market gets. However, the spread might differ depending on the financial asset you could be trading.

For example, a forex pair such as EUR/USD will have a different spread to a commodity such as gold. However, the actual spread of these two financial assets will stay the same regardless of price changes.

This happens when you trade through a broker that uses a ‘dealing desk’ model, meaning they purchase large positions from liquidity providers in order to offer those positions to traders in smaller sizes.

This could be beneficial as capital requirements are usually smaller, and a trader always knows the transaction costs.

On the other hand, traders who choose to trade fixed spreads could experience some drawbacks, such as requotes or slippage.

Requotes occur in highly volatile markets when prices are rapidly changing, so the transaction might get blocked when a trader wants to open a position at a specific price. At this point, they might receive a requote message asking to accept the newly quoted price for the same trade.

Slippage occurs when prices are changing so rapidly the broker cannot maintain the fixed spread, which happens after a trader enters a position but ends up paying a different amount for the position to the one they intended.

What are variable spreads?

Variable spreads are the opposite of fixed spreads, which constantly change as the bid and ask prices change.

The bid and ask prices can change due to trading volume, liquidity, volatility, and supply and demand, which, in turn, could affect the spread to widen or tighten.

This type of spread is offered by brokers who don’t use the ‘dealing desk’ method, which means they receive their prices from various liquidity providers and offer them to their traders.

Variable spreads could be beneficial because traders won’t experience requotes due to more transparent pricing, as the broker receives prices from various liquidity providers. 

Unfortunately, slippage in any of these two types of spreads is possible.

For scalpers, trading variable spreads won’t necessarily be ideal because widened spreads could take away from their potential profits.

What are the trading charges involved with spreads?

As mentioned at the beginning of this article, the spread can be seen as compensation for the broker as well as the transaction cost to execute a trade.

Now, if you’re trading CFDs, additional commission fees might still be payable to the broker, including the spread. However, if you’re spread betting, there might not be any additional commission fees payable, as most spread betting brokers don’t charge a commission.

When trading an asset, it might be essential to remember that the price first has to move beyond the spread to see potential profits.

So, if you are looking to open a long position, the price must first move above the spread before potential profits could be taken. The same is true for when you might want to open a short position; the price must first move below the spread before any potential profits could be made.  


People also asked

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Tight spreads indicate that many market participants agree on an asset’s bid and ask price. This indicates a higher level of trading volume.
There is also the indication that liquidity levels are high and volatility levels are low, which usually comes with a lower level of risk as prices are more stable. Also, the transaction cost to execute a trade is lower.

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Wide spreads are the opposite of tight spreads, where few market participants agree on an asset’s current bid and ask price. The fewer market participants also indicate lower levels of trading volume.
There is also a higher level of volatility with a lower level of liquidity. This could also indicate a higher level of risk as prices change rapidly.
With wide spreads, the transaction cost is also higher.

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For the most part, trading with a tighter spread can be seen as less risky as it indicates a higher level of liquidity and trading volume with a lower level of volatility.

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The bid-ask spread is the difference between an asset’s ask (buy) price and the bid (sell) price. The asking price is the price traders will use to open a long position, and the bid price is the price traders will use when they might want to open a short position.
Traders will also find that the ask price will always be higher than the bid price.

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The spread cost is the transaction cost to give the broker permission to execute a trade on a trader’s behalf. This can also be seen as compensation that goes towards the broker.
The spread cost doesn’t include any potential commission fees issued by a broker.

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