So, how do you think traders make money when prices constantly shift, and buyers and sellers rarely agree on the exact price? The answer lies in understanding spread. This small price difference between buying and selling creates a balance that allows trades to go through even in volatile markets. 

Now, if you’re trading, a narrow spread would lower costs and speed up your profit potential, while a wider spread would demand more substantial price movements. 

Key Takeaways: Spread and Profitability in Trading

• Spread represents the difference between bid and ask prices in trading, impacting entry and exit costs.
• Narrow spreads usually indicate high liquidity, reducing costs for traders.
• Wider spreads raise the cost of trades, requiring greater price movement to achieve profitability.
• Forex trading generally has tighter spreads on major currency pairs like EUR/USD due to high liquidity.
• High-frequency and automated trading systems narrow spreads by increasing market efficiency and liquidity.
• Market conditions, such as volatility, can cause spreads to widen, especially during major economic events.
• Comparing brokers’ spread structures can help in choosing lower-cost options suited to your trading style.
• Effective spread management and timing trades during peak hours can minimize trading costs and enhance profitability.

Let’s discuss in detail to know what is a spread in trading, especially Forex. 

What Is a Spread in Trading?

So, a spread in trading shows the difference between the bid price and the ask price of an asset. The bid price represents what buyers are willing to pay  and the ask price represents what sellers want. Right? Now, the spread is basically a core transaction cost that impacts your profitability. Yes. It directly affects each trade you make.

You’d encounter spreads in every major trading market, including Forex, stocks, and commodities. In Forex, spreads on major currency pairs like EUR/USD range from 1 to 3 pips on average. It is important to know that a pip equals 0.0001 in this currency pair. When trading EUR/USD with a 2-pip spread, you need the market price to move 2 pips in your favor to break even.

New to trading? There are a few things you must grasp about a spread in trading. 

Spreads vary by liquidity in the stock market. Popular stocks like Apple (AAPL) have low spreads, sometimes below 1 cent, due to high liquidity. Lower-traded stocks show higher spreads. Stocks with less liquidity might have spreads closer to 5 to 10 cents per share. Low spreads reduce transaction costs, which makes highly liquid assets attractive for frequent trading.

Smaller spreads often signal high liquidity. High liquidity ensures more efficient trade execution, which can lead to higher profitability. For instance, in Forex, the USD/JPY pair typically has a spread under 3 pips due to its high trading volume. Exotic pairs like USD/TRY have wider spreads, often over 10 pips, because of lower liquidity and higher volatility. Wider spreads mean higher entry costs, which make it harder to gain profit in the short term.

You pay the spread every time you enter or exit a trade. A spread of just 2 pips can add up over multiple trades. So, a trader executing 50 trades a day could pay up to 100 pips in spread costs. Each pip represents a small but significant cost, especially for high-frequency traders.

Relevant Read: What is a Pip in Forex? 

Types of Spreads in Trading

Each spread type applies to different assets and market conditions, while impacting costs and profitability in distinct ways:

1. Bid-Ask Spread

The bid-ask spread is the most common spread, reflecting the difference between the highest price a buyer will pay (bid) and the lowest price a seller will accept (ask) for an asset. This spread applies across various markets, including Forex, stocks, and commodities.

For example, in the stock market, high-liquidity stocks like Apple (AAPL) often have narrow bid-ask spreads, sometimes under $0.01, due to high trading volume. 

According to data from Investopedia, a narrow spread signifies high liquidity, allowing for more efficient trade execution and lower costs for traders. Conversely, low-liquidity stocks with fewer trades might have bid-ask spreads of $0.10 or higher, increasing transaction costs. The EUR/USD pair, known for its high liquidity, typically has a spread of 1-2 pips, which makes it a popular choice for low-cost trading.

2. Fixed Spread

A fixed spread remains constant regardless of market conditions. You should know that fixed spreads provide predictability, which benefits traders looking to plan their costs in advance. Market maker brokers typically offer fixed spreads, ensuring that spread costs do not fluctuate during volatile market periods.

For instance, XM, a major Forex broker, offers fixed spreads on certain account types, which start as low as 1 pip for major pairs like EUR/USD under standard market conditions. During volatile events, like major economic announcements, fixed spreads remain the same, but this could also mean delayed trade execution, a drawback known as “requotes.” The impact of this consistency in costs? It helps swing traders and long-term investors manage predictable trading fees.

3. Variable Spread

Variable spreads, as the name suggests, fluctuate with market conditions. Non-dealing desk brokers generally offer variable spreads, which they source from multiple liquidity providers. Variable spreads can be narrower during high liquidity periods, such as the overlap of major trading sessions, but they widen during volatile times or low liquidity periods.

For example, a variable spread for the GBP/USD pair could drop to as low as 0.5 pips during the London and New York overlap but might increase to 3-4 pips during a major economic announcement. 

This type of spread offers traders potentially lower costs during stable markets, but the spread expansion during volatility could increase trade entry and exit costs. Unfortunately, yes. It is challenging for high-frequency traders.

4. Yield Spread

A yield spread is commonly used in bond and fixed-income markets, where it measures the difference between the yields of two bonds with similar maturities but different credit ratings. It is important to know that yield spreads help investors assess the risk-reward potential between bonds of varying credit quality.

For example, a 10-year U.S. Treasury bond might yield 2%, while a 10-year corporate bond with a lower credit rating might yield 5%. The yield spread here is 3%, indicating the added yield investors demand for the increased risk of holding corporate debt. 

According to Morningstar, a widening yield spread may signal increasing credit risk in corporate bonds whereas a narrowing spread often indicates investor confidence in the corporate bond market.

5. Credit Spread

In bond and options markets, credit spreads show the yield difference between a corporate bond and a government bond of the same maturity, or they describe options strategies that involve buying one option and selling another. In bonds, the spread highlights the extra return required for taking on credit risk. In options trading, credit spreads are used to create risk-controlled strategies.

For instance, in options, a bull put spread involves selling a put option at a higher strike price and buying another put at a lower strike price. Yes. It can generate income with limited risk, as profits occur if the stock remains above the higher strike price at expiration. 

According to the Chicago Board Options Exchange (CBOE), credit spreads enable traders to limit losses while creating income-generating trades, which makes them popular in conservative options strategies.

6. Forex Spread

The spread is the difference between the buying and selling price of a currency pair, calculated in pips. Right? Forex spreads vary significantly based on the currency pair’s liquidity and market volatility. Major pairs like EUR/USD typically have tight spreads because of high liquidity, while exotic pairs like USD/TRY have wider spreads due to lower trading volumes.

For example, as reported by the broker OANDA, the spread for EUR/USD often ranges between 1-2 pips, while the USD/ZAR pair can have spreads of up to 15 pips or more. Forex spreads are a primary transaction cost in Forex trading. So, it makes tight spreads critical for day traders and scalpers who rely on small, frequent profits. 

The Financial Times notes that spreads often widen during high-volatility events, such as central bank announcements, which impact the profitability.

7. Option Spread

Option spreads involve simultaneously buying and selling options contracts on the same underlying asset but with different strike prices, expiration dates, or both. Option spreads help limit risk and optimize trading costs by balancing long and short positions in options.

For instance, a bull call spread involves buying a call option at a lower strike price and selling another at a higher strike price. If a stock trades at $50, a trader might buy a $45 call and sell a $55 call. See, such a strategy limits risk to the net premium paid and profits if the stock price stays above $45 at expiration. 

There’s one more thing to know about option spreads. According to the CBOE, option spreads offer controlled risk profiles, which makes them suitable for traders who manage costs and risk in volatile markets.

Related: Forex vs. Stocks: Which Market to Choose?

How Does Spread Affect Profitability in Trading?

The spread increases your transaction costs, which directly impacts your profitability. 

Every trade incurs the spread cost. It means that each time you open or close a position, the spread amount reduces your potential profit. In high-frequency trading, this cost adds up quickly, which makes spread a critical factor for profitability.

When you trade, the spread functions as a “break-even point.” You need the asset price to move by at least the spread amount in your favor just to cover this cost. For example, in Forex, a common spread for the EUR/USD pair is 1-2 pips. If you enter a trade with a 2-pip spread, the market must move 2 pips in your direction to reach break-even. 

Now, if you’re a short-term trader, especially a scalper, you’d target small price movements, right? So, even a minor increase in spread can reduce profits significantly (Investopedia).

You should know that spreads also vary depending on the asset’s liquidity and market conditions. A report by the Forex market analytics firm stated that major currency pairs like USD/JPY show spreads as low as 1-2 pips because of high liquidity. This low spread reduces costs, all while benefiting day traders who prioritize frequent, low-cost transactions. Conversely, exotic currency pairs, such as USD/ZAR, can have spreads of 20 pips or more, which raises entry and exit costs, in turn, increasing the challenge of profitable trading.

You probably don’t know but timing also affects the spread and thus, your trading costs. During major trading hours—like the overlap of the London and New York sessions in Forex—the spread often tightens, thanks to high liquidity. T

The Financial Times reports that spreads widen during periods of low liquidity, such as after market hours or during major news events, which increases costs. This variation can influence decisions like when to enter or exit trades to optimize profitability.

Lastly, you need to know that broker selection is another factor which affects the spread you pay. Many brokers offer either fixed or variable spreads. Fixed spreads remain constant, which provides predictability, but they may limit trade execution during volatile periods. 

Variable spreads fluctuate with market conditions, which can offer tighter spreads during stable periods. It is worth noting that variable spreads can go as low as 0.6 pips on major pairs under normal conditions but may expand during volatility. So, you must choose the right broker with competitive spreads to lower trading costs, and ultimately boost your profit potential.

How to Calculate Spread in Forex Trading?

You’re clear on what is a spread in trading? Now, you must thoroughly understand the trading costs and potential profitability. Let’s learn to calculate spread like a pro:

Identify the Bid and Ask Prices

Firstly, you need to locate the bid and ask prices of the currency pair you are trading. Remember Brokers typically list these prices in the trading platform. For example, if you are trading EUR/USD, you might see the bid price at 1.1050 and the ask price at 1.1052.

• Bid Price: 1.1050 (price at which you can sell)
• Ask Price: 1.1052 (price at which you can buy)

Apply the Spread Formula

You need to use the spread formula to find the difference between the ask and bid prices:

Spread=Ask Price−Bid Price\text{Spread} = \text{Ask Price} – \text{Bid Price}Spread=Ask Price−Bid Price

In the example of EUR/USD, the calculation would be:

1.1052−1.1050=0.00021.1052 – 1.1050 = 0.00021.1052−1.1050=0.0002

Convert the Spread to Pips

The spread in Forex trading is usually measured in pips, which represents the smallest unit of price movement in a currency pair. In order to convert the calculated spread to pips, you have to look at the last decimal place in most currency pairs (for EUR/USD, that’s the fourth decimal).

For our example:

0.0002=2 pips0.0002 = 2 \text{ pips}0.0002=2 pips

Here, the spread for EUR/USD at that moment is 2 pips, which represents the cost of entering or exiting a trade.

Technology’s Role in Spread Reduction

Let’s see how specific technologies impact spreads and why they are critical in reducing trading costs:

1. High-Frequency Trading (HFT) Drives Liquidity

High-frequency trading (HFT) uses algorithms to process trades in milliseconds. HFT firms serve as market makers, providing continuous buy and sell prices across assets. 

According to the Bank for International Settlements, HFT has significantly increased liquidity, especially in Forex markets, which leads to narrower spreads. Major currency pairs like EUR/USD see spreads as low as 0.1 pips during peak market hours due to HFT activity, as noted by Skilling in 2024.

2. Automated Trading Systems Enhance Market Efficiency

Automated trading systems reduce human errors, executing trades quickly without manual input. Brokers use these systems to keep spreads competitive by matching orders instantly. 

Research by Quadcode Group shows that automated systems improve trade execution times, which help traders save costs when spreads tighten during active market hours (Quadcode Group, 2024).

3. Online Platforms Improve Transparency

Advanced trading platforms give you real-time access to prices, enabling you to compare spread rates across brokers. Platforms like MetaTrader 4 (MT4) and MetaTrader 5 (MT5) offer high execution speeds and low spreads. 

According to XM, access to live data lets you make informed decisions without hidden costs.

4. Blockchain Reduces Costs in Cryptocurrency Trading

Blockchain technology allows peer-to-peer transactions without traditional intermediaries. You can trade directly with other parties, which reduces transaction fees and spreads. 

Although cryptocurrency spreads can be volatile, you can expect narrower spreads on major coins like Bitcoin and Ethereum (Investopedia, 2024).

5. Artificial Intelligence (AI) Analyzes Market Conditions in Real Time

AI algorithms assess market conditions and liquidity levels, instantly. The results are precise and nearly perfect. So, brokers use AI to adjust spreads based on real-time supply and demand, which provides fairer pricing. 

It’s for sure that AI especially benefits Forex traders, as spreads for popular currency pairs fluctuate based on accurate, automated data analysis. No chance for human errors. 

6. Cloud Computing Reduces Latency

Cloud-based trading solutions let brokers manage large volumes of data, just to ensure fast and accurate pricing. 

Yes. Cloud computing cuts operational costs, which allows brokers to offer tighter spreads, especially during periods of high trading activity. You can benefit from low-latency trading, particularly in liquid markets like the stock and Forex markets (Axiory, 2023). 

Also Read: What is Forex Sentiment Analysis?

Final Words

It is important to understand how spreads work because they impact your trading costs and directly affect profit margins. Now, if you are looking for faster returns, you need to select assets with narrow spreads during high-liquidity periods to significantly reduce costs. 

Here comes an important strategy. Spread betting offers an alternative approach, which allows you to capitalize on price movements without asset ownership. It suits short-term strategies well, where the spread itself is the main trading cost, and narrow spreads help minimize it.

Unlike traditional trading, spread betting involves lower upfront costs and can offer tax advantages in certain regions. However, remember that leveraged trading, like spread betting, magnifies both gains and losses. You need to choose the right spreads and apply solid risk management to ensure profitability.