What is Spread in Trading? Understanding It in One Article

Many people might think that trading is simply about buying low and selling high, making a profit from the difference. However, there are small details in trading that you need to be cautious about, such as trading fees or spreads, which can unknowingly affect your profits or losses if you don't calculate them carefully before opening or closing a position.

Today's article will help everyone understand spreads to ensure your trading doesn't risk losses from this small variable.

What is a Spread?

A spread refers to the difference between the price at which we can buy (Ask) and the price at which we can sell (Bid) an asset at a given moment. It's akin to a hidden fee that traders must pay to brokers or service providers. The wider the spread, the higher the trading costs, which in turn reduces expected profits.

Understanding spreads helps traders plan strategies and calculate returns more accurately. Additionally, the size of the spread reflects market liquidity and volatility at that particular time. Generally, major currency pairs tend to have narrower spreads than minor pairs due to higher trading volumes.

What are the types of Spreads?

Generally, there are two main types of spreads. Both have their advantages and disadvantages. The choice depends on one's trading style and personal preference. Some prefer the certainty of fixed spreads, while others may favour the flexibility of variable spreads, regardless of which one chooses. 

• Fixed spread

This is akin to a shop with set prices. No matter how busy or quiet the market is, the price remains the same. This type of spread is often found with Market Maker brokers. The advantage is that we can predict trading costs in advance. However, it may not always reflect actual market conditions. 

• Variable spread

This is similar to a shop that adjusts prices based on customer demand. During busy market periods, the spread may narrow, but when the market is volatile, the spread may widen. This type of spread is commonly found with ECN brokers. The advantage is that it better reflects actual market conditions, but it may make cost prediction more challenging.

Why do we need to know about Spreads?

Understanding spreads is crucial for all traders, as they form part of the trading costs we must pay. Spreads are fees charged by brokers and directly impact our trading profits and losses, especially when we trade frequently. The more often we trade, the more apparent the impact of spreads becomes. 

Moreover, spreads are a factor we should consider when looking for a suitable broker. Brokers offering lower spreads can help us save on trading costs, potentially increasing our profit opportunities.

How can we benefit from Spreads?

We can start by selecting an appropriate trading time, focusing on periods of high market liquidity, such as when the London and New York markets are open simultaneously, which typically have narrower spreads than other times. Additionally, avoiding trading during major economic news announcements can help reduce the risk of wider spreads. 

Another method is to concentrate on trading major currency pairs with high liquidity, like EUR/USD, which usually have narrower spreads than minor currency pairs. 

Adjusting trading strategies to account for spreads is also worth considering, especially for short-term trading, where profit targets should be set higher than the spread. For long-term trading, the impact of spreads is reduced, allowing for more distant profit targets.

Periods when spreads tend to be high

• When currency pair markets are not open simultaneously
  When the market for one of the currencies in the pair we're trading is not yet open, it often results in higher-than-normal spreads.

• Low liquidity periods
  Especially when major markets are not yet open, such as late night or early morning in Thai time, low liquidity leads to wider spreads.

• During important economic news announcements
  When significant economic news is released, market volatility increases, resulting in much wider spreads.

• Market opening and closing times
  During the opening or closing hours of markets in different regions, volatility may occur, leading to higher spreads.

• During significant economic or political events
  Unexpected events or crises can cause market volatility and higher spreads.

How to reduce the impact of high Spreads?

We can mitigate this impact through various methods. Start by finding a broker offering low spreads, which will save costs on every trade. Additionally, choosing the right trading time is crucial, focusing on busy market periods, such as when London and New York are open simultaneously, as high liquidity often leads to narrower spreads. Conversely, avoid trading during important news releases, as volatility may cause spreads to widen significantly. Another option to consider is an ECN account that charges commissions instead of spreads, which may be suitable for frequent traders.

Recap

Understanding spreads is crucial for all traders, whether novice or professional, as they are hidden costs that directly affect trading profits and losses, especially for those who trade frequently or in the short term. We should understand the types of spreads, both fixed and variable, to choose a broker that suits our trading strategy. In the next article, we will delve deeper into the types of spreads, so stay tuned.