22 July 2020

Photo by Burak K from Pexels

As a beginner trader or investor, you may have some questions regarding online trading. Some of those questions might revolve around what trading spreads are and how they work. Sometimes things are a little bit complicated at first but don’t worry, we are here to help!

What is the Spread?

In trading, the spread is the difference between the buying price and the selling price. Buy and sell prices are also known as the offer, ask, and bid. Usually, the bid price is lower than the ask price. That means that the underlying market is between those two prices. 

Spreads are used by brokers, market makers, investors, and traders. They use it to add costs to a specific trading opportunity. They base the cost of an asset on its supply and demand. Depending on how expensive and volatile the asset is, the spread will fluctuate. This fluctuation depends heavily on the trading volume.

As a result, using spreads is a key element of contracts for difference or CFD trading. 

How Do Spreads Work?

Spreads are a crucial piece of trading information. They are necessary for making an accurate analysis of trading costs. As we mentioned above, an asset’s price can change. Knowing an asset’s spread number helps traders and investors to understand how it is going to impact the value of the trade. This is entirely based on how tight the spreads in the market are.

Nonetheless, the tighter the spread is, the better value you could get as a trader. Furthermore, this means that one can make a profit or loss from even small movements in price. This, to many traders, is an advantage.

Relative Value Trading

Spread trading can also be known as Relative Value Trading. This is used as a method for determining an asset’s worth by taking into account the value of similar assets. Moreover, we can also define spread trade as the act of buying an asset and selling another related asset as a unit. 

They are priced as a unit or as pairs for future exchanges.

What is the Bid-Ask Spread?

The most commonly used spread is a bid-ask spread. As we mentioned before, the bid stands for the “buy” price, whereas an ask or offer represents the “sell” price. This one is the most used because it is one of the best ways to portrait the supply and demand for an asset.

So, if the bid and offer prices are too close together, there is a consensus between buyers and sellers. That means both buyers and sellers agree over how much the asset is worth. But, if the spread is wider, then it means that there is a significant difference in their opinions.

What Influences the Bid-Ask Spread?

Also, the bid-ask spread can be highly influenced by a range of factors, including:

  • Liquidity: This is how easy it is to buy or sell certain assets.
  • Volume: This is how much of the asset that is traded daily.
  • Volatility: This is how much the market fluctuates. 
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Can You Use Spreads in your Favor?

Absolutely!

Once you place your trade, you will be looking for the market to move further than the price of the spread. As a result, if you manage to achieve this when you close your trade, you’ll make a profit by buying your sell trade. Of course, this also can be the other way around – selling your buy trade. 

Keep in mind that there are other potential costs to consider. Some markets can ask for a commission charge or a combination of spread plus commission.

Conclusion

In summary, the spread is calculated based on the last highest numbers of the buy and sell prices. Spreads are one of the key elements for trading – they allow you to know the difference between the prices. Do not forget that they also help you to analyze the market so that you can gain profits instead of losing them. If you know how to use them, they can do wonders for your trades.

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