In finance, a spread can mean more than one thing. The spread is usually defined as the difference between two prices, rates, or yields.
One of the most common definitions of the spread is the difference between the bid price and the ask price of a security or asset, such as a stock, bond, or commodity.
This difference is called a "bid-ask spread."
It turned out that many new traders don't pay any attention to spreads at all.
In this post, we'll talk about what the market spread is and how it can sometimes ruin a trade that seems good at first.
No matter what kind of financial instrument we trade, if we want to buy an asset, we have to find someone who is willing to sell it to us.
If we want to sell an asset, we have to find someone who wants to buy it.
The market makes it easy for people to buy and sell things. The price of an asset is based on the current supply and demand.
But even the most liquid markets have two prices: the ask price and the bid price.
Ask price is the lowest price that market participants are willing to sell the asset to you, and bid price is the highest price that market participants are willing to buy the asset from you.
Almost never are the bid and ask prices the same. Their difference is called their spread.
The size of the spread depends on how busy the market is.
Higher liquidity means more people are trading and more people are trading, which makes it easier for people to make an exchange.
On these markets, the spreads are lower.
On the other hand, markets with low trading volumes are called "less liquid." This makes it harder for market participants to find a trade partner.
Most of the time, spreads are high on such a market.
Spreads must always be taken into account when figuring out the risk-to-reward ratio of a trade.
For scalpers and day traders, a spread that is higher than usual can ruin a trade that seems good at first.
Always look at the spreads before you start trading.
The credit spread is another name for the yield spread. The yield spread is the difference between two different investment vehicles' quoted rates of return.
The credit quality of these vehicles is usually different.
Some analysts say that the yield spread is the difference between the yields of X and Y.
This is usually the annual percentage return on investment of one financial instrument minus the annual percentage return on investment of another.
The yield spread must be added to a benchmark yield curve for the price of a security to be discounted so that it matches the current market price.
The name for this changed price is an option-adjusted spread. Usually, this is used for mortgage-backed securities (MBS), bonds, options, and interest rate derivatives.
The option-adjusted spread is the same as the Z-spread for securities with cash flows that are not affected by changes in interest rates.
The Z-spread is also known as the zero-volatility spread and the yield curve spread. Mortgage-backed securities use the Z-spread.
Spread is the result of zero-coupon treasury yield curves, which are needed for discounting a cash flow schedule that has already been set up to get to its current market price.
This kind of spread is also used to measure credit spread in credit default swaps (CDS).
What are spread charges?
One way that traders pay to execute a position is through the spread. For some assets, like stocks, the provider won't use a spread, but instead will charge based on a commission.
For other assets, the provider might use a mix of spreads and commissions.
When trading products with a spread, a trader hopes that the market price will rise above the price of the spread. When this happens, the trade can be closed with a profit.
Even if the market moves in the direction the trader thought it would if the price doesn't move more than the cost of the spread, the trader may have to close the trade at a loss.