The word ‘spread’ has a variety of definitions in other areas of finance, but the fundamental concept of being a difference between two prices is always evident. A spread in trading is the difference between the buy (ask) and the sell prices (bid) of an asset.
Spread in Trading – Key Takeaways
- The spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). It represents a key cost in trading, embedded in the buy and sell prices, and affects the overall profitability of trades;
- In forex trading, the spread is measured in pips, which are small price movements typically at the fourth decimal point. The spread is calculated by subtracting the bid price from the ask price. Tighter spreads mean lower trading costs and are generally preferred by traders;
- The spread varies depending on factors such as liquidity (ease of buying/selling an asset), trading volume, and market volatility. High liquidity and volume usually result in tighter spreads, while high volatility and low liquidity lead to wider spreads;
- Forex spreads are variable, meaning they fluctuate with market conditions. Important news events or increased volatility can widen spreads, potentially increasing trading costs and risks, such as margin calls or position closures;
- Traders can reduce spread costs by avoiding thinly traded assets and trading during peak market hours when liquidity is higher, and spreads tend to be tighter. Choosing reputable brokers like NAGA and understanding spread dynamics is also crucial to avoid manipulation and excessive costs.
What is a spread?
The spread is the gap between the highest price someone wants to buy at and the lowest price someone is willing to sell at and needs to be factored into the explicit commission charged for executing the trade.
Where there is an efficient market - such as forex - with a lot of people both wanting to buy and sell in equal amounts, that gap will be very small.
It is an implied cost because you only feel the effect in subsequent trades, as the asset you bought must increase above the level of the Spread, rather than the price you bought at, for you to make a profit.
The spread is one of the key costs involved in online trading. Generally, the tighter the spread, the better value you get as a trader. NAGA offers low market spreads to all clients, irrespective of their account types and trade sizes. To provide efficient and attractive conditions for all clients, we constantly adapt them to suit traders across all markets.
Visit our markets page for more information about our spreads.
How does spread in trading work?
The spread is a crucial piece of information to be aware of when analyzing trading costs. An instrument’s spread is a variable number that directly affects the value of the trade.
Spreads are constructed around the current price or market price of an asset. Market makers and brokers may add some transactional costs in the spread to simplify the transaction process, which can be particularly prevalent in futures contracts.
Several factors influence the spread in trading, as follows:
Liquidity
This refers to how easily an asset can be bought or sold. As the liquidity of an asset increases, the bid-ask spread usually tightensVolume
This is a method of reporting the quantity of an asset that is traded daily. Assets that have a higher trading volume will often have narrower bid-offer spreadsVolatility
This is a measure of how much the market price changes in a given period. During periods of high volatility, when prices change rapidly, the spread is usually much wider
What is the Spread in Forex?
The spread in forex is a small cost built into the buy (bid) and sell (ask) price of every currency pair trade. When you look at the price that’s quoted for a currency pair, you will see there is a difference between the buy and sell prices – this is the spread or the bid/ask spread.
Changes in the spread are measured by small price movements called pips – which is any change in the fourth decimal place of a currency pair (or second decimal place when trading pairs quoted in JPY). It is not only the spread that will determine the total cost of your trade, but also the lot size.
Remember, every forex trade involves buying one currency pair and selling another. The currency on the left is called the base currency, and the one on the right is called the quote currency. When trading FX, the bid price is the cost of buying the base currency, while the ask price is the cost of selling it.
With us, you can trade forex using derivatives like CFDs, 24 hours a day. Derivative products enable you to take a position on forex without taking ownership of the underlying asset. You can go long or short, which means you can speculate on rising as well as falling currency prices. And you only need a small deposit – called margin – to open your position.
The margin on a forex trade is usually only 3.33% of the value of the trade, which means you can make your capital go further while still getting exposure to the full value of the trade. Note, that while margin can magnify your profits, it will also amplify any losses.
How to calculate the spread
NAGA platform calculates the spread automatically, so you do not have to, but it is still useful to know where our spread costs come from.
To calculate the spread in forex, you have to work out the difference between the buy and the sell price in pips. You do this by subtracting the bid price from the ask price. For example, if you’re trading GBP/USD at 1.3089/1.3091, the spread is calculated as 1.3091 – 1.3089, which is 0.0002 (2 pips).
Spreads can either be wide (high) or tight (low) – the more pips derived from the above calculation, the wider the spread. Traders often favor tighter spreads, because it means the trade is more affordable.
If a market is very volatile, and not very liquid, spreads will likely be wide, and vice versa. For example, major currency pairs such as EUR/USD will have a tighter spread than an emerging market currency pair such as USD/TRY. However, spreads can change, depending on the factors explained next.
Why does the spread change in forex?
The spread in forex changes when the difference between the buy and sell price of a currency pair changes. This is called a variable spread – the opposite of a fixed spread. When trading forex, you will always deal with a variable spread.
The forex spread may increase if there is an important news announcement or an event that causes higher market volatility. One of the downsides of a variable spread is that, if the spread widens dramatically, your positions could be closed, or you’ll be put on a margin call. Keep an eye on the economic calendar to stay abreast of upcoming financial events.
Know your spread
It’s very important to know the spread in the financial markets. The spread is the cost of each transaction that the broker charges and determines if that cost is appropriate for your trading strategies.
Secondly, all investors and traders should be educated about the lack of information regarding the possibility of manipulating the spreads on their trading platforms without the consent of their clients. On certain occasions, there are unscrupulous brokers who exercise this practice to obtain more profits. Therefore, t’s essential that the trader choose a reliable forex broker with a good reputation and that is not guilty of any spread manipulation. It is also advisable to trade with a highly regulated company since the regulators require companies to meet strict requirements regarding the financial products and services such as the safety of clients’ funds in segregated accounts.
Even if you work with brokers that do not engage in any tampering, let’s go back to the importance of the spread as it represents the cost to the trader. A trader that trades with low spreads will have less operating cost and long-term savings. Therefore, a high-spread trader will have to generate higher profits to offset the cost. For many traders, the spread is very important in their losses and gains. For example, if a trader makes many short-term trades (scalping or day trading) a high spread can result in absorbing most of their profits. For a long-term trader in which each trade generates a certain amount of pips in profit, the spread is a matter of little relevance since it has little impact on the results of the trading.
How to Manage and Minimize the Spread
You have two ways of minimizing the cost of these spreads:
- Avoid buying or selling thinly traded assets. Multiple market makers compete for business when you trade popular instruments, such as the major currency pairs, blue-chip stocks, global stock indices, and top cryptocurrencies. If you trade a thinly traded instrument, there may be only a few market makers to accept the trade. Reflecting the lessened competition; they will maintain a wider spread.
- Trade only during the most favorable trading hours, when many buyers and sellers are in the market. As the number of buyers and sellers for a given instrument increases, competition and demand for the business increase, and market makers often narrow their spreads to capture it.
Final Words about Spread
Trading spreads are implemented by market makers, brokers, and other providers to add costs to a trading opportunity, based on supply and demand. Depending on how expensive, volatile, and liquid an asset is, the spread will fluctuate along with an asset's price and trading volume.
- A spread is the cost of a trade, built into the buy and sell price of an asset
- In forex, the spread is measured in pips, which is a movement at the fourth decimal place in a forex pair’s quote (or second place if quoted in JPY)
- To calculate the spread, subtract the buy price from the sell price
- Spreads are always variable, whereas other markets’ spreads may be fixed
- Spreads can either be wide (high) or tight (low)
- Traders often favor tighter spreads, because it means the trade is more affordable
- If a market is very volatile and not very liquid, wide spreads may occur
- If a market has high liquidity but is not very volatile, tighter spreads may occur
- Factors like important news announcements or an event that causes higher market volatility can cause spreads to change
