Spreads differ between trading instruments due to variability in liquidity, supply, and demand for these instruments in the market. The gap between the bid and ask prices represents the cost of executing the transaction and the profit for the broker. In this blogpost, Headway experts share the full list of factors that define the spreads for your trading instruments.
Who calculates spreads?
The spread between the bid price and the ask price is typically determined by trading brokers. When you engage in trading, you will notice that there is a difference between the bid price and the ask price. This difference is usually referred to in points or pips. A pip is the smallest change in the value of the price for the instrument.
The price at which a trader can buy an instrument is known as the bid price, while the price at which a trader can sell the instrument is known as the ask price.
For example, the bid price for the EURUSD currency pair is 1.2000 and the ask price is 1.2005. In this case, the spread is 5 pips.
What affects spreads?
The factors that affect the spread of instruments include:
Market activity and liquidity. If there is high liquidity in the market for the financial instrument, the spread will likely be lower. This means that there is abundant availability of bids and offers, reducing the difference between the bid price and the ask price.
Time. Time gaps in trading instruments can increase their spread, especially when the market opens after the weekend or important announcements. Moreover, during periods of low liquidity such as overnight closures or market holidays, the spread may temporarily increase.
News. When significant economic data such as major economic reports are released, it can increase price volatility and, consequently, the spread. You can monitor such events in the Headway economic calendar.
Financial instruments. Financial instruments can have different spreads based on their unique characteristics. For example, foreign currencies may be known for relatively low spreads, while small-cap stocks may exhibit higher spreads due to their limited liquidity.
Market conditions. During periods of high instability or major geopolitical events, the spread may temporarily increase. These conditions can cause increased price fluctuations and reduced liquidity, resulting in a wider spread.
The balance of supply and demand for instruments affects their spread, as an increase in demand or supply can result in a narrower spread.
What may also play a role?
Trading volume. Trading volume can affect the spread. When trading volume is high, the spread is usually lower due to sufficient bids and offers to meet the demand.
Operational costs. Trading brokers incur operational costs in providing trading services and charge the difference between the bid and the ask as fees. The spread may be affected by these operational costs.
The spread can vary between trading brokers and different financial instruments. Before making a trading decision, review the available conditions and compare the spreads to choose instruments that suit your needs.