How important is Spread in trading? An article to understand it fully

If you are just entering the world of forex and cryptocurrency trading, you will often hear the word “Spread.” But this concept is crucial for developing trading strategies because it directly affects your trading costs and profit margins. Today, we will take an in-depth look at what exactly Spread is.

What is Spread?

Spread refers to the difference between the Bid price and the Ask price when trading an asset. This concept applies to forex, stocks, cryptocurrencies, and other trading markets.

In actual trading:

• Forex trading: Spread is the difference between the Bid and Ask prices of a currency pair
• Stock trading: Spread is the difference between the stock’s selling price and buying price
• Cryptocurrency trading: Spread is the difference between the digital asset’s Bid and Ask prices

Simply put, the Spread is this price difference. For example, if you see a Bid price of 1.05672 and an Ask price of 1.05680 on the EUR/USD pair, the Spread is 0.8 pips. This means that if you buy and sell EUR/USD immediately, you will lose 0.8 pips, and the exchange benefits from this difference.

What can Spread tell us?

The size of the Spread often reflects the market’s liquidity conditions. In normal forex markets, the Spread is usually very small, possibly only 0.001%. But if you find a market with a Spread of 1% or 2%, it indicates that the market’s liquidity is quite limited, and traders may face higher risks in that market.

When the market experiences sharp volatility (such as during the release of important economic data), the Spread will widen rapidly. This is because the supply and demand relationships among market participants change dramatically, causing the gap between Bid and Ask prices to increase.

Fixed Spread vs Floating Spread: Two different trading modes

Trading platforms typically offer two Spread modes. Understanding the difference between these two is essential for choosing the right trading method.

Fixed Spread

Definition: Fixed Spread is preset by the broker and remains unchanged under all market conditions.

Advantages:

• Predictable trading costs, making it easy to calculate expenses precisely
• For traders with a planned approach, it provides clarity on the fees they will pay

Disadvantages:

• During high market volatility, “Requote” phenomena may occur. That is, when the market moves rapidly, the broker may refuse to execute your trade at the original quote and ask you to accept a new price. This is very unfavorable for traders who want to enter and exit the market quickly
• Requotes interrupt your trading process and disrupt your trading plan

Floating Spread (Variable/Floating Spread)

Definition: The floating spread varies in real-time based on market supply and demand, determined by market prices rather than solely by the broker.

Advantages:

• Avoids Requote issues, allowing smoother trade execution
• During periods of high liquidity (especially peak market hours), spreads are often lower than fixed spreads
• More beneficial for active traders who trade frequently

Disadvantages:

• Spread is unstable, especially during market volatility (such as during non-farm payroll releases), where it can suddenly widen from 2 pips to 20 pips
• Not suitable for ultra-short-term traders, as costs cannot be predicted accurately
• May cause confusion for novice traders, who could suffer unnecessary losses due to sudden spread widening

Which one to choose?

There is no absolute answer. The best choice depends on your trading style and experience level:

Suitable for fixed spread traders:

• Small traders who prefer stable costs
• Risk-averse traders
• Investors seeking predictable trading costs

Suitable for floating spread traders:

• Experienced active traders
• Professional traders who frequently enter and exit the market
• Institutional investors making large trades during peak market hours
• Fast traders who want to avoid Requotes

Practical tips

Regardless of which Spread mode you choose, remember this golden rule: The more frequently the Spread fluctuates, the harder it is to profit.

To reduce trading costs, it is recommended to:

1. Choose brokers with relatively stable spreads
2. Prioritize trading highly liquid currency pairs, such as EUR/USD and GBP/USD, which typically have spreads much lower than less common pairs
3. Trade during high liquidity periods, avoiding trading in quiet market times

Understanding the essence of Spread can help you evaluate trading costs more rationally and develop more scientific trading strategies. Remember, successful trading is not about luck but about solid knowledge and careful planning.