Spreads in Trading

If you’ve ever placed a trade and wondered why there’s a small gap between the buy and sell price, you’ve already encountered spreads in trading. Understanding what that gap means, and how it affects your trades, can help you make more informed trading decisions.

A spread in trading is the difference between the bid price and the ask price of a financial instrument. It represents part or all of the transaction cost, depending on the broker’s pricing model.

What Are Spreads in Trading?

The spread is the difference between the bid price (what you can sell at) and the ask price (what you can buy at). Brokers display both prices simultaneously, and that gap forms part of the cost of entering a trade. On some account types, a separate commission may also apply.

A simple way to think about it is exchanging currency at an airport. The rate you buy at and the rate you sell at are never the same. The difference helps cover the cost of providing liquidity and, depending on the broker’s pricing model, may also form part of the broker’s revenue.

Spreads in trading exist across almost every market, including forex, indeks, commodities, stocks, and more. They’re included in the quoted buy and sell prices, although some account types also charge a separate commission.

If EUR/USD has a bid price of 1.1050 and an ask price of 1.1052, the spread is 2 pips. If you buy at 1.1052, the market generally needs to rise by 2 pips before the trade reaches break-even, excluding any commissions or other trading costs.

Fixed vs. Variable Spreads in Trading

Not all spreads in trading work the same way. There are three common pricing models involving spreads:

• Fixed spreads remain constant under normal market conditions, although some brokers may widen them during periods of extreme volatility
• Variable (floating) spreads change based on liquidity and volatility
• Raw spread accounts typically offer spreads that are closer to the underlying market, with a separate commission charged

Fixed spreads give you predictability. Variable spreads can be tighter during calm markets but widen sharply during news events or low-liquidity periods. Raw spread accounts can be well suited to active or high-frequency traderswho want the tightest possible prices.

The right pricing model depends on your trading style, preferred markets, and how often you trade.

How Spreads Affect Trading Costs

How Position Size Affects Spread Costs

Spread costs are often overlooked, especially by newer traders. Every time you open a position, your unrealised profit or loss initially reflects the spread, meaning the market must move in your favour before the position breaks even, excluding any commissions or overnight financing costs (where applicable).

On a major forex pair like EUR/USD, spreads are typically very tight. On exotic pairs or less liquid instruments, they can be significantly wider. Wider spreads reflect lower liquidity and higher execution risk in the underlying market.

As your position size increases, so does the monetary impact of the spread. A one-pip spread on a small position may have only a limited impact. Scale that up, and it becomes a meaningful cost across dozens of trades per week.

When Spreads Widen and Why It Matters

Why Spreads Widen

Variable spreads change throughout the trading day as market conditions change. Several conditions cause spreads to widen:

• Major economic data releases, like inflation figures or employment reports
• Central bank announcements
• Periods of low market liquidity, such as around market close or during holiday trading

During periods of sharp volatility, spreads on equity-related instruments can widen significantly as liquidity temporarily declines.

A trader entering a position during that window may pay a much higher implicit cost than usual.

Volatile markets can still present trading opportunities, but it’s worth considering the extra cost of wider spreads before entering a position.

How to Trade Smarter Using Spreads

Understanding how spreads work is only part of the picture. Factoring them into your trading decisions can help you manage costs more effectively.

The first step is knowing what you’re paying. Before trading any instrument, check the current spread and compare it to your expected profit target. If your target is 10 pips and the spread is 3 pips, the spread represents 30% of your intended profit target before the market moves.

Scalpers are generally more affected because they target smaller price movements. A strategy built around small, frequent gains can be eroded by spreads in trading if the instrument isn’t liquid enough. Swing traders, who hold positions for hours or days, feel the impact proportionally less because they’re targeting larger moves.

Choosing the Right Account and Instrument

Spreads in trading vary not just by market conditions but by the account type you hold.

Instrument choice matters just as much. Major forex pairs tend to carry the tightest spreads. Commodities like gold and oil are highly liquid during major trading sessions, which can contribute to relatively tighter spreads. Exotic pairs and niche instruments are where costs can quietly eat into your results.

Focus on the markets you know well, and check the typical spread before building a strategy around a new instrument.

How to Read Spreads on a Trading Platform

On most platforms, you’ll see the bid and ask prices displayed side by side. The difference is the spread, usually shown in pips for forex or points for indices and commodities.

Traders who track their spread costs alongside their P&L can gain better insight into how trading costs affect their overall performance.

One thing worth watching: the spread at the moment you’re looking isn’t necessarily the spread you’ll get when you execute. During fast-moving or volatile markets, prices can change rapidly. If you’re trading during a news release, execution and pricing may shift between the moment you click and the moment your order is filled.

Why Monitoring Spreads in Trading Matters

Successful traders don’t just focus on market direction they also pay attention to trading costs. Monitoring spreads in trading over time can help you identify when markets are most liquid and when trading conditions are less favourable. Some traders choose to avoid entering positions during major economic announcements or outside peak trading hours, when spreads may widen unexpectedly. Keeping an eye on average spreads for the instruments you trade can help you plan entries more effectively and avoid unnecessary costs, particularly if your strategy relies on frequent trades or relatively small price movements.

Summary

Spreads in trading are a fundamental part of how markets work and how trading costs are structured. They’re a normal part of trading and should always be factored into your trading costs.

Before placing any trade, ask yourself: what’s the current spread, what’s my target, and does the math still work? Making this a routine part of your trade planning can help you manage costs and evaluate potential trades more effectively.

For a deeper look at account types, live spreads across 500+ instruments, and tools to help you trade with more confidence, visit IronFX.

DISCLAIMER: This information is not considered as investment advice or an investment recommendation, but is instead a marketing communication.