What is spread trading strategy and is it profitable?

Investing in the financial market can be tricky, harsh and sometimes daunting. Indeed, the vocabulary used daily by brokers and other specialists in the field is not particularly inherent to newbie traders.

If you want to invest in the financial markets and start online trading, you should therefore find out precisely about the specifics of such jargon and learn spread trading ins and outs. In this piece of writing, we help you understand the principles of spread trading. 

Besides, we explain the important factors to consider if you want to venture into spread trading and incur decent profits. Let’s see what spread trading involves and what is the spread trading strategy exactly, shall we? 

What is the bid-ask spread?

The bid-ask spread, integral to option contracts and spreads, reveals the price discrepancy in asset trading, signifying supply and demand dynamics. 

A narrow spread indicates agreement between buyers and sellers, while a wide spread signifies disagreement. Liquidity, volume, and market volatility profoundly influence this spread. Understanding option spreads is crucial for navigating complex trading environments.

Forex trading spread explained – Spread in Forex trading.

In foreign currency trading, the spread is the difference between the bid (sell) price and a currency pair’s ask (buy) price. 

The bid-ask or bid offer spread is basically the difference between the highest price that a buyer is going to pay for the asset and the lowest price that a seller wants to accept. Traders looking to sell will receive the bid price, while one looking to buy will pay the ask price.

There are always two prices in a currency pair, the bid price and the ask price. The first one is the price at which you can sell the base currency, while the ask price is the price you use to purchase the base currency.

Understanding the Bid-Ask Spread

The bid-ask spread, integral to option contracts, spreads, and calendar spreads, reveals the price discrepancy in asset trading, signifying supply and demand dynamics and considering expiration dates, strike prices, and market prices. 

A narrow spread indicates agreement between buyers and sellers, while a wide spread signifies disagreement, influencing transaction costs. 

Liquidity, volume, and market volatility profoundly influence this spread, affecting various types of spreads, including simultaneous buying and selling of options or futures contracts. 

It’s important to note that spread may widen, emphasizing the need to grasp these nuances for navigating complex trading environments.

How to measure the spread: Spread calculator

The spread is measured in pips. It is a small unit of price movement of a currency pair and the last decimal of the price (equal to 0.0001). It’s applicable for most currency pairs, except the Japanese Yen, where the pip is two decimal places (0.01).

When the spread widens, it means there is a bigger difference between the two prices, so liquidity is usually low and volatility high. In contrast, a lower spread shows low volatility and high liquidity. Therefore, a smaller spread cost becomes incurred when trading currency pairs with a tighter spread.

When you trade, the spread can be variable or fixed. Indices, for example, have fixed spreads. The spread for currency pairs is variable, so when the bid and ask prices of the currency pair change, the spread also changes.

Nevertheless, in the world of trading, this term is used to designate the difference between two rates. Most of the time, it corresponds to the difference between a financial instrument’s purchase price (ask) and the sale price (bid). 

It is in particular thanks to this sum of in-betweens that your broker, namey trading platform you use, is paid for the services offered.

Understanding Spread Calculations

In trading jargon, this spread is expressed in quotation or “pips” units. Contrary to what these somewhat weird terms might suggest, there is nothing very complicated. Indeed, to calculate a spread, all you have to do is make a simple subtraction between the bid price and the ask price. 

Also, for an asset bought at €40.35 and resold at €40.30, the spread is 0.05. A very important instrument in trading, the spread is closely monitored by the many brokers present on the market. 

Note that the closer the spread is to zero, the more the investment is attractive and the transactions facilitated.

Can spread trading be profitable?

Spread trading can be profitable for more experienced and skilled traders who pay attention to the following aspects of trading.

• Trading Tighter Spread Securities
• Building a Structured Trading Plan
• Structuring the Entry and Exit
• Right Market and Right Instrument Selection
• Prepare, Plan, and Practice Before Entry
• Controlled Use of Leverage

Forex Spread Indicators

The spread indicator is usually displayed as a line on a chart to show the direction of the spread relative to bid and ask prices. This helps visualize the spread in the currency pair over time, with more liquid pairs having tighter spreads and more exotic pairs having wider spreads.

Factors that influence the Forex spread include market volatility, which can cause fluctuations. Major economic news, for instance, can cause a currency pair to strengthen or weaken, thus affecting the spread. If the market is volatile, currency pairs may experience spreads. Or the currency pair becomes less liquid, so the spread will widen.

Keeping an eye on an economic calendar can help you prepare for the possibility of wider spreads. By staying informed about events that could make currency pairs less liquid, you can make an informed prediction about the possibility of their volatility increasing and, therefore, the spread widening. However, preparing for breaking news or unexpected economic data can be difficult.

There will also be a lower margin for currency pairs traded in large volumes, such as major pairs containing the dollar. These pairs offer higher liquidity. But they see exposure to the risk of spread widening in the event of economic volatility.

During large trading sessions, such as those in London, New York and Sydney, spreads are likely to be lower. In particular, when there is overlap, for example, when the London session ends, and the New York session begins, the spread can be even tighter. The general supply and demand of currencies also affects the spread. If the demand for the Euro is high, the value will increase.

Spread and margin

If the Forex spread widens significantly, you run the risk of receiving a margin call. And, in the worst case, being liquidated. A margin call notice occurs when your account value falls below 100% of your margin level, indicating that you may no longer be covering trading requirements. All your positions are at risk of liquidation if you reach 50% below the margin level.

Bottom Line: Choose Your Broker Wisely

For profitable investments, selecting the right broker is crucial. Take your time to gather sufficient information before deciding. Today, many online brokers offer different spreads. Prioritize finding one with the closest margin to zero.

Consider additional fees charged by brokers, such as account opening, management, and inactivity fees, to anticipate costs effectively.

While numbers matter, don’t overlook the importance of quality customer service. Opt for a reputable broker who communicates clearly and is readily available to assist you.

Be cautious of financial market regulations. Your broker should inform you about market conditions and services but not manage your money or provide investment advice.