In order to make money, a trader needs to take into account changes in the price of assets when other market participants are looking for better conditions for transactions. A classic and effective source of income is the difference in quotations. Those who make money from price fluctuations take into account the size of the spread. Failure to do so can turn profits into losses. We tell you what a spread is in trading, how to use it to make money, what beginners need to familiarize themselves with, and what nuances to take into account when concluding contracts.
The spread between bid and ask: the essence of the concept
The spread on the stock exchange is the difference between the offer (ask) and demand (buy) prices for a market asset at a specific moment in time. Pronounced “spread”. Comes from English spread, which translates as “spread”, “span”. This difference exists because buyers want to buy as cheaply as possible, and sellers want to sell the asset at a higher price. Each of the parties is in no hurry to change its position. These are the basic concepts of trading on the stock exchange. It is necessary to take into account that points are used to measure the spread, and not monetary units.
Brokerage offices receive income from spreads. It is necessary to understand that it is not investors who carry out transactions on the stock exchanges, but brokers, it is just that their activities remain out of the spotlight. Depending on the rates of the brokerage company, the income may vary. Commissions and the amount by which the “ask” exceeds the “bid” are the main means of income for intermediaries. There are two types of stock market spread:
Swimming. Varies within some range. Its value can change every minute, depending on the market situation. Found on stock exchanges and Forex. Such a tool is of interest to traders in the long term. With its help, you can find the right moment to open a position. The minimum spread is set by market makers (counterparties), many of which may be brokerage companies. The size of its value increases when advancing to the price maker (trader/investor). These are the two main players in any market deal.
fixed The formation of such a spread can be observed in cases where one market operator ensures simultaneous purchase and sale. In most cases, this happens when trading currency, in particular with intermediaries on the international Forex market. And here the difference between the “bid” and “ask” currency prices is fixed. On the stock market, this type of spread is found in margin trading of CFD contracts.
This indicator is significantly affected by the depth of bid and ask. An increase in this value can be observed when fewer buyers place limit orders to buy shares, currency, futures, or fewer sellers place limit orders to sell. In order to guarantee the success of using a limit purchase order, it is necessary to take into account the value of the spread.
After assessing the market situation, in order to earn income, the seller lowers the “ask” when the price falls. If the price increases, the buyer increases the “bad”. You can see the purchase/sale prices of the asset in the “glass” of the trading terminal, which contains all the necessary information about the transactions. At all price levels, the market participant can estimate how much of the currency securities they want to buy/sell at that price. Usually, selling prices are highlighted in red on top, purchase prices are highlighted in green below.
How the concepts of spread and liquidity are related
The difference in the liquidity of the asset determines the cost between bid and ask from some securities, currencies to others. Spread between sellers and buyers is a de facto measure of liquidity. Its meaning is different for different markets. The relationship is inverse — the smaller the spread, the higher the market liquidity.
Forex is considered the most liquid market. The spread on it has the lowest values (1/100%). Shares of well-known issuers (Google, Apple, Tesla) are in high demand, so they are characterized by a small difference between the bid and ask prices. A fixed spread often occurs when the market is highly liquid. Low trading volumes are typical for securities issued by little-known companies that are not of interest to investors. In this case, the difference between bid and ask is high.
A trading spread also often reflects the market maker’s risk exposure when offering a deal. Thus, the difference between bid and ask in options and futures often has a much larger percentage of their value compared to currency and stock trading. The width of this range is affected by both liquidity and the rate of price change.
Examples of the difference between bid and ask
When the asset’s bid is $39, and its ask is $40, then the value of the spread in this case is $1. This value can be specified as a percentage. Most often, it is calculated as a percentage of the lowest selling price.
For the described example, the spread is calculated as follows:
$1 ÷ $40 × 100% = 2.5%.
The spread will close when a potential buyer makes an offer to buy the asset at a higher price or a seller wants to sell it at a lower price.