Spread in trading is the difference between the buy and the sell price

2 min read

What is Spread in Trading?

Before you understand what is spread in trading, you should understand that in the foreign exchange market prices are represented as currency pairs or exchange rate quotation. The relative value of one currency unit is denominated in the units of another currency. An exchange rate, applied to a customer willing to purchase a quote currency is called BID. It is the highest price that a currency pair will be bought. And the price of quote currency selling is called ASK. It’s the lowest price that a currency pair will be offered for sale. BID is always lower than ASK. 
The difference between ASK and BID is called spread.  It represents brokerage service costs and replaces transactions fees.
When you look at most financial markets, you’ll see three prices: the market price, buy price and sell price. The difference between the buy and the sell price is clarification of what is spread. It’s a simple concept, but one that could have a significant impact on the profitability of your trades.
Spread is traditionally denoted in pips, a percentage in point, meaning the fourth decimal place in currency quotation.

More about what is spread

In the most general sense, a spread is a difference between two similar measures. In the stock market, for example, it is the difference between the highest price bid and the lowest price asked. 
With fixed-income securities, such as bonds, the spread is the difference between the yields on securities having the same investment grade but different maturity dates. For example, if the yield on a long-term Treasury bond is 5%, and the yield on a Treasury bill is 2%, the spread is 3%.
What is Spread in Trading? 2
The spread may also be the difference in yields on securities that have the same maturity date but are of different investment quality. For example, there is a 4% spread between a high-yield bond paying 9% and a Treasury bond paying 5% that both come due on the same date.
The term also refers to the price difference between two different derivatives of the same class.
For example, you can find typically spread between the price of the October wheat futures contract and the January wheat futures contract. Part of that spread is known as the cost of carry. However, the spread widens and narrows, caused by changes in the market. Well, in this case, the wheat market. 

More answers to what is spread in trading

It is a difference between the asking price and an offer. For example, if the seller was asking $2 million but the offer was only $1,5 million, the spread would be $500,000.
Also, it is a difference between the cost of money and the earning rates.
For instance, a mortgage banker is able to borrow money at 6% interest because of its excellent credit and high net worth. It then loans that money out on moderately risky ventures at 14%  interest. The spread is 8%.

What is spread trade?

A spread trade or value trade is the simultaneous purchase of one security and sale of a related security, called legs, as a unit. Spread trades are usually executed with options or futures contracts as the legs. But other securities sometimes can be used.

What is Spread in Trading? 3

The difference between ASK and BID is called spread. It represents brokerage service costs and replaces transactions fees.
Following types of spreads are used in Forex Trading:
Fixed spread – the difference between ASK and BID is kept constant and do not depend on market conditions. They are set by dealing with companies for automatically traded accounts.
Fixed spread with an extension – a certain part of a spread is predetermined and another part may be adjusted by a dealer according to market.
Variable spread – fluctuates in correlation with market conditions. Generally,  the variable spread is low during times of market inactivity (approximately 1-2 pips), but during volatile market can actually widen to as much as 40-50 pips. This type of spread is closer to the real market but brings higher uncertainty to trade and makes the creation of effective strategy more difficult.

What influences the spread in Forex Trading?

There are several factors of spread influence in trading. The most important is currency liquidity. Popular currency pairs are traded with lowest spreads while rare pairs raise a dozen pips spread. Next factor is the amount of a deal. Middle size spot deals are executed on quotations with standard tight spreads; extreme deals, both too small and too big, are quoted with broader spreads due to risks involved.
On the volatile market, bid-offer spreads are wider than during quiet market conditions. Status of a customer also impact spread as large-scale traders or premium clients enjoy personal discounts. Forex market characterizes high competition and as brokers are trying to stay closer to customers, spreads tend to be fixed on the lowest possible level.
Each trader should pay sufficient attention to spread management. Maximum performance can only be achieved when the maximum quantity of market conditions is taken into account. The successful trading strategy is based on effective evaluation of market indicators and specific financial conditions of a deal.  Speaking about the spread in trading, the best tools here are complex analysis, forecasting, risk/return analysis, transaction cost evaluation. Because spreads are subject to change, spread management strategy should also be flexible enough to adjust to market movement.
Every market has a spread and so does Forex. A spread is simply defined as the price difference between where a trader may purchase or sell an underlying asset. Traders that are familiar with equities will synonymously call this the Bid: Ask spread.

Spread’s costs and calculations

Since the spread is just a number, we need to know how to relate the spread into dollars and cents. If you can find the spread, finding this figure is very mathematically straightforward once you have identified pip cost and the number of lots you are trading.
For example, you can buy the EUR/USD at 1.3564 and close the transaction at a sell price of the 1.35474.T hat means as soon as our trade is open, a trader would incur 1.4 pips of spread. To find the total cost, we will now need to multiply this value by pip cost while considering the total amount of lots traded. When trading a 10k EUR/USD lot with a $1 pip cost, you would incur a total cost of $1.40 on this transaction.
Remember, the pip cost is exponential. This means you will need to multiply this value based off of the number of lots you are trading. As the size of your positions increase, so will the cost incurred from the spread.
What is important to know?  It is important to remember that spreads are variable. That means they will not always remain the same and will change sporadically. These changes are based on liquidity, which may differ based off of market conditions and upcoming economic data. To reference current spread rates, always reference your trading platform. 
Risk Disclosure (read carefully!)

What's your reaction?
Leave a Comment