Low Spreads? Keeping Your Trading Costs Down

What Is Considered a Low Spread?

Trader shocked while reading trading costs

The spread is often the bane of a trader’s existence. Not accounting for spread can make an otherwise successful trading strategy into a losing one, and failing to check the spread before entering a trade during a period of increased volatility can leave you in a very uncomfortable position.

Needless to say, understanding the bid-ask spread and finding a broker that offers the best spread is very important. But before we can clarify what is considered a tight spread, we need to first get on the same page about what spread is in the first place.

Sellers and Buyers

The spread, also known as the bid-ask spread, is essentially the difference between the lowest price that a seller will accept for their contracts and the highest price that buyers are willing to pay for them.

Let’s look at an example. Imagine that the market’s sellers will sell their contracts of EUR/USD for no less than 1.17158 per contract (the ask), but buyers will pay no more than 1.17192 per contract (the bid). In this case, the spread would be $0.00034, or 3.4 pips (1.17192 – 1.17158). If you were to enter a trade with $100,000, you would immediately enter the trade at a $34 loss (not accounting for commission fees).

In reality, the spread isn’t quite as simple, but this is a good way to conceptualise it. The spread is actually set by the market maker, who determines the bid and ask on its own. However, this level of technical understanding isn’t entirely necessary.

What Is a Bid/Ask Spread?

There is no set criteria or cutoff point for what counts as a tight spread, but you can generally think of anything in the low single digits as tight spread. Generally, a tight spread will be between 0 and 3 pips.

For example, TradeDirect365 offers fixed spreads of 0.9pts on the Aussie 200, 0.6 pips on AUD/USD, and 0.7 pips on USD/JPY.

A few brokers such as TradeDirect365 will offer fixed spreads, which means that the spread is set in stone — it won’t change at all regardless of the market conditions. However, most brokers offer spreads that still fluctuate somewhat.

Even if you are using a tight spread broker, it’s important to monitor the spread whenever you make a trade. Sometimes the spread can spike up suddenly, turning a good trade into a bad one and possibly hitting your stop levels.

What Market Factors Affect Spread?

The spread can tell you a lot about the market. It is constantly changing (unless you’re using a fixed spread), and it varies based on the market’s conditions.

Typically, a tight spread indicates that there is a period of low volatility, high liquidity, or both. This means that the price isn’t experiencing huge swings or lots of traders are in the market, making it easy to buy large numbers of contracts without much market impact.

Conversely, a high spread usually means that there is high volatility, low liquidity, or both. In this case, the price is moving a great deal or it’s difficult to buy or sell contracts.

This makes sense if you think about it: during periods of low volatility, things move along quite smoothly. But when the price starts to jump, sellers will hold on for dear life and buyers will scramble to get in on the spike, driving the spread up.

Similarly, if there aren’t many traders in the market, it will be harder to settle on a price, driving the spread higher. If there’s a lot of liquidity, on the other hand, there are more people willing to buy and sell at any time, making the spread tighter.

Evaluating Broker Costs?

A small spread is a good way to keep trading costs low. However, it isn’t a silver bullet. A small spread doesn’t automatically indicate that a broker has low trading costs.

To truly evaluate a broker, you will need to take all its trading costs into account, including commission. Some brokers will offer a small spread in exchange for a higher commission fee, which can lead to practically no change in overall trading costs.

Whenever you choose a broker, make sure you take the full picture into account and ensure that the costs line up with your strategy. For some, having a slightly larger spread is preferable to a higher commission and vice versa.

The Bottom Line

Finding a broker with a tight spread and low commission fee is the holy grail, but often there’s a trade off. Overall, the most important thing is to find a broker that is first and foremost reputable and trustworthy, as a tight spread won’t mean much if you can’t withdraw your money.

If you’re looking for a low cost broker, TradeDirect365 currently offers low, fixed spreads on all CFDs. Click here to find out more. TradeDirect365 YouTube https://www.youtube.com/c/TradeDirect365?app=desktop