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 called the spread.
It’s a simple concept, but one that you’ll come across often when trading financial markets – and it could have a significant impact on the profitability of your trades.
Why is the spread important?
Tighter spreads tend to mean lower trading costs, as long as everything else is equal. This is because a tighter spread means that the market price doesn’t have to move as far from your entry price for your trade to become profitable.
Who sets the spread?
When you are trading assets like shares, forex or commodities, the spread is dictated by other participants in the market. If you are trading at market price, the offer is the lowest price at which you can buy, and the bid is the highest price at which you can sell.
When you are trading derivatives like CFDs or spread betting, your provider will often add their own spread on top of the market price. This spread represents the fee you are paying to trade the derivative.
What changes the spread?
Other than pricing, a number of factors can influence the size of the spread.
- In general, the more people who are buying and selling a particular market, the tighter its spread. If there are fewer participants, spreads tend to widen.
- Volatility, such as that brought about by major news or economic announcements, can cause large market movements that lead to increased spreads. This is to cover the increased risk of volatile markets.