Have you ever heard the term spread in trading? Actually, what is the spread? Let’s learn more thoroughly about trading spreads in the following article!
What is Spread in Trading?
The definition of spread in the world of trading, namely the margin or the value of the difference between the buying price (ask) and the selling price (bid) of currencies between traders and brokers.
The broker charges this margin value to the trader for transactions carried out by both and is not charged separately.
It is from these fees that the broker gets a profit (profit). Therefore, when you, as a trader, use the services of a broker to make a profit, there will be a commission or fee that must be borne later.
Therefore, avoid being tempted by brokers who provide free services. The reason may be that the commission charged is already in the spread.
Types of Spreads
Do you understand the meaning of spread? Next, you need to know what types of spreads exist.
Note the spread is divided into four types. Here’s an explanation.
1. Spread Trade
Also known as a relative value trade, spread trading buys one-factor security and sells another-factor security as a unit.
This type of spread is done with options or futures contracts. Usually, this activity is completed to produce an overall sales profit with a positive value in the spread.
The spread is priced as units/pairs in the future in the world of exchanges to ensure continuous buying and selling of units of securities.
By doing this spread, there is the elimination of execution risk, with one part of a pair being executed but the other part not being completed.
2. Bid-Ask Spreads
Known as a bid-offer spread or buy-sell, this spread is influenced by several factors, including supply/float and the total amount of outstanding shares available for trading.
The demand factor for an asset and the total trading activity also play an essential role in this spread.
Meanwhile, for security factors, such as future contracts, options, crypto asset pairs, and stocks, this type of spread is the difference between the order, ask, sell, and auction prices.
On the other hand, for stock options, the bid-ask spread will be the difference between the strike price and the market price.
One of the bid-ask spread functions is to measure market liquidity and stock transaction costs.
3. Options-Adjusted Spreads
To reduce the price of a security and match it to the current market price, the yield spread must be added to the benchmark yield curve.
The adjusted price is known as the option-adjusted spread.
Generally, this spread is used as collateral for collateral, bonds, and interest rate derivatives.
4. Yield Spreads
Also known as a credit spread, a yield spread is a type of spread that shows the difference between the quoted return rates of two investment vehicles.
Usually, these facilities are distinguished according to the credit quality of each.
Some analysts refer to this as the “yield spread of X over Y.” What usually appears is the annual percentage of return on investment from a financial instrument minus the annual percentage return from an investment vehicle.
How to Measure Spreads
To measure the spread, three calculation methods can be done.
1. Floating Spreads
The floating spread is a measure of changes in spread according to market fluctuations, for example, EURUSD.
When trading is active, market liquidity is high, and spreads will narrow.
However, on the other hand, when trading is not active, and market liquidity is low, the spread will widen.
2. Fixed Spreads
A fixed spread means that the spread has no effect outside of a flat or volatile market.
For example, EURUSD has a fixed spread of 3 points, and USDJPY has a fixed spread of 4.
Some brokers apply this spread because it is an indicator of market liquidity.
This is the broker’s way of understanding this concept and facilitating marketing.
Some unscrupulous brokers secretly increase spreads, provide fixed spreads, deceive customers, and then charge customers/traders.
3. Zero Spreads
Zero spread is 0 pips charged by the broker. However, it does not mean that this broker’s spreads are not constant to 0 pips.
The reason is that some forex brokers stipulate that a zero spread has the same meaning as a spread lower than one pip.
So, the term zero spread also applies to the spread range of 0.5 pips; 0.2; 0.1; etc.
Spread is the value of the difference (margin) between the buying price (ask) and the selling price (bid) of a currency between a trader and a broker.
Brokers will charge these fees or commissions. Payment to traders for transactions carried out by both—not charged separately.
The types of spreads consist of Trade Spread, Bid-Ask Spread, Options-Adjusted Spread, and Yield Spread.
Meanwhile, to measure the spread, the methods that can be used are Floating Spread, Fixed Spread, and Zero Spread.
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