Learn Risk Management

Many new traders will often overlook spread and not see its significance – or rather simply not know what it is. But spread is very important to learn about. Once understood, a trader can begin to combat the spread and has a better chance of being profitable. But what is spread and why is spread important to your trading?

1. What is spread?
2. Why is spread taken?
3. How is spread taken?
4. Example of spread in trading
5. Why is spread important?
6. What is the spread with ETX?
7. Is it possible to beat the spread?
8. Tips on how to beat the spread 
9. Why do spreads widen?

1. What is spread?

Spread is the difference between the buy and sell price of a market. So, for instance, if a market’s buy price is £1.05 and sell price is £0.95, the spread is £0.10. Another way of thinking about spread is that it’s effectively the commission paid to the broker. With brokers applying the spread to the buy and sell prices, those figures are based on the actual value of an asset but are almost never the exact price. The actual value would be somewhere in the middle of the spread, in this case £1.00.


2. Why is a spread taken?

A spread is taken to cover the broker’s cost for executing orders. It costs all brokers to place the trades on your behalf, not to mention the cost of developing the platforms, paying employees, marketing etc. It takes a large amount of money for a broker to operate, and this is partially financed by the spread taken from clients - a primary source of funding. Without it, brokers would risk not being able to be financially sustainable as they’d rely solely on traders losing money to earn profits.

3. How is spread taken?

The spread is taken automatically when you open and close positions. You will not have to do anything manually to contribute towards the spread. As established previously, the spread is the difference between the buy and sell price. So, when you open a trade, the spread (broker’s commission) is taken automatically via the buy price being higher than the asset’s actual price and the sell price being slightly lower. The small differentiation between the buy/sell price and the actual price means the trader is slightly undercut on value. This is the spread that’s collected by the broker.

4. Example of spread in trading

A long position on Apple is opened for £1 per point at a price of £1.05. Apple’s actual value and share price is trading at £1.00, and its sell price at that time is £0.95.

If Apple’s price then rises to £1.50, the buy price would be £1.55 and the sell price £1.45. If the long position is then closed, it would be closed at the sell price of £1.45. At £1 a point, the profit made on the trade would be £40.

Apple trade opened at: £1.05
Apple trade closed at £1.45
Profit on Apple trade at £1 a point: £1.45-£1.05 x £1 (per point) = £40

Actual value of Apple when trade opened: £1.00
Actual value of Apple when trade closed: £1.50
Actual difference and would-be profit without spread = £50

In this example, the spread taken by the broker is £10. Percentage wise, this is proportionally quite large. Typically, the spread taken will be a lot smaller.

Spread

In this image taken of the Bitcoin (USD) market on our TraderPro platform, the Sell price is 10120.4 and the Buy price is 10179.1. This is a difference of over 58 points (58.7), and equates to the spread. It may seem like a lot, but in relative terms it's only a little over 0.5% of the total value of Bitcoin at that time.. In other words, Bitcoin only needs to move (just over) 0.5% in your favour for you to beat the spread and your trade to become profitable. 

5. Why is spread important?

Spread is important to know about as it makes trading profitably marginally more difficult. Using the example above, let’s say a long position was opened on Apple for £1 a point at a price of £1.05 – where the actual price is £1.00. If Apple’s actual price then rises to £1.05, the sell price will be £1.00. So, if the position is closed, despite Apple’s price rising the trade is not profitable as the £5 taken in spread cancels out the £5 profit made.

Understanding this concept is vital for a few reasons. For one, it should affect your strategy. At some point, it may be tempting to open a position with the intention of closing it very soon after to take advantage of a market that is experiencing rapid short-term gains. In theory, this would be profitable, but taking the spread into account will mean that the trade ends up losing the trader money.

It also means that you should think twice about closing trades. If you are, for instance, looking to reopen a position on the same market shortly after, the spread means you’ll lose more than if you were to keep the existing one open.

6. What is the spread on each market at ETX?

At ETX Capital, we offer highly competitive spread rates for all of the markets on the TraderPro and MT4 platform.

Visit our Trading Costs page to see spreads for FX, Indices, Crypto, Shares, Commodities and Bonds & Interest rates markets for spread betting and CFDs on both TraderPro and MT4.

7. Is it possible to beat the spread?

It’s very possible to beat the spread – by that we mean be profitable on a trade despite spread being taken. The spread is typically a very small proportion of the trade size, so it’s rare that the market prices rise but the trade remains unprofitable due to the spread.

It’s just worth considering the reduction of the spread when thinking about trading involatile or ‘quiet’ markets. If a market has remained around the same price for months and shown little sign of fluctuating, it will be difficult to trade it profitably in the short term.

8. Tips on how to beat the spread

Think about each trade carefully

As mentioned, trading ‘dormant’ markets will likely put you in the red as its price will be less likely to rise above the point at which the spread is cancelled out by the profit. Think about each trade carefully before placing it. There’s no worse feeling than placing a trade and instantly regretting it. You then feel an obligation to keep it open until the cost of the spread is recouped, but that in itself could then lead to even greater losses as there’s no guarantee the market will rise again.  

Look for smallest spread

Some markets can correlate with one another, meaning price movements are either based on the same things or based on the other markets directly. Bitcoin and Altcoins is one example. Typically, a Bitcoin surge will cause the main Altcoins (Ethereum, Ripple, Litecoin) to surge as well. So, if the spread offered on Litecoin is smaller than that offered on Bitcoin, it may be worth investing in the former if you want to take advantage of a general crypto rally.

Don’t close positions too soon

A fundamental mistake that new traders make is closing positions too early. The spread will instantly put your trades in the red, but don’t be deterred. Of course, if the market you have traded on is falling rapidly and you are worried about losses, then close the trade. But if it’s been a few days and your trade is steady but still unprofitable, it might need a longer time to become profitable.

Evaluate why its unprofitable and try to determine what the chances of it becoming profitable are. Then based on your evaluation, either wait it out or close the position – but don’t just immediately close it without thought because it’s losing money.

9. Why do spreads widen?

When you place a trade, you are effectively taking on the broker as they assume the risk and are the ones who will pay you out if your trade is profitable. When markets are specifically volatile and it’s completely unclear as to which way the market will go and by how much, brokers are obtaining more risk by accepting trades. This is because a market is more likely to make a greater move, which could lose the broker a lot of money. So, to counter this risk, a broker might widen the spread.