What Is the Bid Ask Spread?
If you trade the financial markets, or read about them, you will have most heard of the bid ask spread. But do you understand what it means? The bid ask spread is an important concept to understand, because it has a direct impact on the one thing all traders care about: their potential profit. In this article, we will explore this term in detail, explain what influences it, how to measure it and more!
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What Is the Bid Ask Spread?
So, what is the bid ask spread? In order to understand this term, you need to firstly be aware of what the bid price and ask price are.
When trading a financial instrument, you will always see two prices; the bid and the ask. If you want to open a buy position in the market, you pay the ask price. If you want to open a sell position, you accept the bid price.
The bid price tends to be lower than the ask price, meaning that if you bought an asset and sold it immediately, you would lose money. You would also lose money if you sold, then bought immediately.
The bid ask spread, or simply the spread, is the difference between these two prices and is one of the main sources of revenue for a brokerage.
In the image above, we can see that, at the time it was captured, Alphabet (Google) shares currently had a sell (bid) price of $2,729.98 and a buy (ask) price of $2,731.26. The bid ask spread formula is simple, it is just the difference between these two prices, which is equal to $1.28.
In the Contract Specification section of the Admirals website, you can see the typical spread for all the financial instruments we have available to trade.
Why Is it Important?
For longer term investors who plan to buy an asset, such as a company's shares, and hold onto it for an extended period of time, the bid ask spread will most likely not cause much concern nor greatly affect their decision making process.
However, for those who trade over a shorter time horizon, such as scalpers, day traders and even swing traders, the bid ask spread will play a much larger role.
This is because in order for their trades to become profitable, the market needs to move in their favour by an amount larger than the difference between the bid and ask prices. The larger the bid ask spread, the larger the required price movement.
What Factors Affect the Spread?
Now we have an answer to the question 'what is the bid ask spread?' and we know how it is calculated, let's take a look at the main factors which can affect its value.
Liquidity
The main factor which affects the size of the bid ask spread is the liquidity of the financial instrument in question. The higher the liquidity, the tighter the spreads. A lack of liquidity usually results wider spreads.
High liquidity indicates a high volume of trading activity, where the market is not heavily dominated by either buyers or sellers, allowing for trading of the asset to take place easily, quickly and with minimal price disturbance.
Brokers are more inclined to offer lower bid ask spreads where there is high trading volume, because it is easier and less risky for them to execute trades under these conditions.
On the other hand, in markets which are not frequently traded, brokers are inclined to charge more for handling the transaction resulting in wider bid ask spreads.
For example, in the Forex market, the major currency pairs have much higher liquidity and, therefore, tighter spreads than the exotic currency pairs.
Volatility
The volatility of a financial instrument also affects the size of its spreads. During periods of high volatility, spreads tend to widen, partly because brokers wish to take advantage of the volatility to profit, but also because it presents higher risk for them.
For this reason, the bid ask spread on lots of instruments tend to be wider around times of important economic announcements. With our economic calendar, traders can easily keep track of such announcements.
How to See the Bid Ask Spread in MetaTrader 5
In MetaTrader 5 you can easily see the bid ask spread of each instrument in the following way:
- Open your MetaTrader 5 trading platform
- Head to the 'Market Watch' window on the left-hand side of your screen
- Now right click on any of the financial instruments which are currently listed. Select 'Columns' and then click 'Spread' as shown below.
- Once you have done this, a new column will appear in the 'Market Watch' window which acts as a bid ask spread calculator. This new column shows the spread for all the instruments you have listed in pips
Can You Avoid the Spread?
You might be wondering if there is any way that you can avoid paying the bid ask spread in order to increase your potential profit.
The Zero.MT5 account from Admirals benefits from spreads which start from zero on various markets! Commission applies at up to $6 per contract.
Spreads vary from broker to broker, but you should be very careful of advertisements promising no spreads and no commission as these may well turn out to be trading scams.
Final Thoughts
You should now fully understand the concept of the bid ask spread and its importance to traders.
Of course, each trader will have a different degree of sensitivity to the spread depending on their style and strategy. For those who enter and exit the market on a frequent basis, the cost of the spreads can soon start to add up.
Demo Trading with Admirals
Traders who choose Admirals will be pleased to know that they can practise trading on a risk-free demo account, absolutely free! A demo account is the perfect place for a beginner trader - or an experienced trader testing a new strategy - as it allows you to trade in real-market conditions with virtual funds. Interested? Click the banner below to open your free demo account today:
About Admirals
Admirals is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
