The Bid Ask Spread - How does it affect your trading?

December 07, 2020 16:30 UTC

If you trade the financial markets, or read about them, you will have most likely come across the term "spread", or perhaps "bid ask spread". But do you understand what it means? This concept is relevant to all traders, regardless of what financial market they are exposed to.

The reason for its importance is that it has a direct impact on something all traders care about: their potential profit. In this article, we will explore this concept in detail, tell you what influences it, how to measure it and more!

Bid Ask Spread

What Is the Bid Ask Spread?

In order to understand the term "bid ask spread", you need to firstly be aware of what the bid price and ask price are.

When trading a financial instrument, you will always see two prices; the bid and the ask. If you want to open a buy position in the market, you pay the ask price. If you want to open a sell position, you pay the bid price.

The ask price tends to be lower than the bid price, meaning that if you bought an asset and sold it immediately, you would lose money. You would also lose money if you sold, then bought immediately.

The bid ask spread, or simply the spread, is the difference between these two prices and is one of the main sources of revenue for a brokerage.

Alphabet Daily ChartDepicted: Admiral Markets MetaTrader 5 - Alphabet Inc. Daily Chart - New Order. Date Range: 20 December 2019 - 2 December 2020. Date Captured: 2 December 2020. Past performance is not necessarily an indication of future performance.

In the image above, we can see that Alphabet (Google) shares currently have a sell (bid) price of $1,822.94 and a buy (ask) price of $1,824.16. Therefore, we can say that the spread is equal to $1.22, or the difference between these two prices.

In the Contract Specification section of the Admiral Markets website, you can see the typical spread for all the financial instruments available to trade through us.

Why Is it Important?

For longer term investors who plan to buy an asset, such as stock in a company, and hold onto it for an extended period of time, the bid ask spread will most likely not cause much concern nor greatly affect their decision making process.

However, for people who trade over a shorter time horizon, such as scalpers, day traders and even swing traders, the spread will play a much larger role.

This is because in order for their trades to become profitable, the market needs to move in their favour by an amount larger than the difference between the bid and ask prices. The larger the spread, the larger the required price movement.

What Factors Affect the Spread?

Liquidity

The main factor which affects the size of the bid ask spread is the liquidity of the financial instrument in question. The higher the liquidity, the tighter the spreads. A lack of liquidity presents wider spreads.

High liquidity indicates a high volume of trading activity, where the market is not heavily dominated by either buyers or sellers, allowing for trading of the asset to take place easily, quickly and with minimal price disturbance.

Brokers are more inclined to offer lower spreads where there is high trading volume.This is because it is easier and less risky for them to execute trades in these conditions.

On the other hand, in markets which are infrequently traded, brokers are inclined to charge more for handling the transaction resulting in the wider spreads.

For example, in the Forex market, the major currency pairs have much higher liquidity and, therefore, tighter spreads than the exotic currency pairs.

Volatility

The volatility of a financial instrument also affects the size of its spreads. During periods of high volatility, spreads tend to widen, partly because brokers wish to take advantage of the volatility to profit but also because it presents higher risk for them.

For this reason, the spread on lots of instruments tend to be wider around times of important economic announcements. With the Admiral Markets economic calendar, traders can easily keep track of such announcements.

How to See the Spread in MetaTrader 5

In MetaTrader 5 you can easily see the spread of each instrument in the following way:

1. Open your MetaTrader 5 trading platform

2. Head to the 'Market Watch' window. If it is not already showing on the left-hand side of your screen, press Control + M to make it appear.

3. Now right click on any of the financial instruments which are currently listed. Select 'Columns' and then click 'Spread' as shown below.

Market Watch MetaTraderDepicted: Admiral Markets MetaTrader 5 - Market Watch

4. Once you have done this, a new column will appear in the 'Market Watch' window showing the spread for all the instruments you have listed. The spread is shown in pips.

Market Watch with Spread MetaTrader 5Depicted: Admiral Markets MetaTrader 5 - Market Watch

Is There Any Way to Avoid the Spread?

You might be wondering if there is any way that you can avoid paying the spread in order to increase your potential profit.

With a Zero.MT5 account from Admiral Markets, you can benefit from spreads which start from zero on various markets! Commission applies at up to $6 per contract.

Spreads vary from broker to broker, but you should be careful of advertisements promising no spreads and no commission as these may well turn out to be trading scams.

Final Thoughts

You should now fully understand the concept of the bid ask spread and its importance to traders.

Of course, each trader will have a different degree of sensitivity to the spread depending on their style and strategy. For those who enter and exit the market on a frequent basis, the cost of the spreads can soon start to add up.

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About Admiral Markets

Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

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