What is a spread?

The spread is the difference between the purchase price of an instrument and its sale price. It belongs to the main costs of transacting. The smaller its value, the lower the cost of trading. Most brokers offer both fixed and variable types of spreads, which allows you to decide which form is more optimal for the actions we take and our investment strategy.

 

What is a spread in the financial market?

This is the difference between the bid price (called ask) and the price of its sale (bid). By opening a position in a given market, the spread is the main transactional cost.

The spread can be seen as the minimum distance the market must move for us to start generating profit.

What are the types of spreads?

Almost all online brokers use the Market Maker model in their operations. It means that they are market makers creating the market and making decisions with the main goal of achieving the greatest possible liquidity.

Most brokers offer both fixed and variable spreads.

Variable spread

This is the option that is by far the most frequently chosen by customers. The price spread fluctuates depending on market conditions. If we observe high liquidity and the moment when the European and American sessions overlap, the spread on the EUR/USD pair is much lower for the Asian session. The spread is wider during periods of lower liquidity, i.e. after the closing period of financial centers in New York and before the opening of Asian markets. Sometimes the spread also widens during or after important events.

Fixed spread

With a fixed spread, the spread is kept at the same level regardless of market conditions. In most cases, the spread is much wider than the variable spread, due to the fact that the broker has to contend with the risk of maintaining it throughout the day – including in markets with high volatility and low liquidity.

What to choose – fixed spread or variable spread?

Here the most important issue is that of speculation. Players whose strategy is based on short-term contracts usually choose variable spreads because of their narrow range during periods of peak market liquidity.

Moreover, they reflect the true nature of the market in this way. Traders with the characteristics of a long-term game, basing their decisions on fundamental analysis usually opt for a fixed spread, which can protect them from spread widening occurring as a result of global macroeconomic events.

Examples of using the spread in the market

For example, in the case of the EUR/USD pair, the spread is quoted at the purchase price – 1.0984, and its selling price is 1.0984 then the value is calculated by subtracting the purchase price of 1.0984 from the selling price of 1.0984, resulting in the generation of a 1 pip spread.

When will you start earning considering the spread?

If you decide to open a position in the EUR/USD pair and the market moves at least 1 pip in the direction of your order then you will start generating profit. This is one of the reasons why immediately after opening a position you initially see a small loss.

Why do banks use a currency spread?

This is caused primarily by the desire to make a profit to please investors and shareholders. Sometimes it helps make money for its customers (if only through interest rates on deposits and savings accounts), but even in this situation it is worth remembering that the bank holding our money also makes money. Why? Because it lends our money to other customers, using instruments such as loans or credits. These carry significantly higher interest rates than deposits and savings accounts.

Why is the currency spread so important?

Its value is particularly important for borrowers who have decided to take out a loan in a foreign currency. In this situation, the spread has a direct impact on the amount of the installment. For several years, Poland has had an “anti-spread law”, which obliges banks to accept credit installments not only in zlotys, but also in foreign credit currencies.