What Is the Spread in Trading?
The spread is the difference between the price you can sell at and the price you can buy at, and it is the cost of trading immediately. You pay half of it entering and half leaving, it never appears on a statement as a fee, and it widens when liquidity thins.
Almost every cost in trading announces itself. A commission appears on the statement, a financing charge appears overnight. The spread does neither — it comes out of the price you were filled at, and that is precisely why it goes unnoticed for years.
How it works
There are always two prices, not one. The bid is what somebody will pay you now. The ask is what somebody will sell to you now. The gap between them is the spread, and the single price shown on most charts is usually the midpoint — a number nobody actually trades at.
It is the price of immediacy. Somebody is standing ready to take the other side of your order the instant you want it, and the spread is what they charge for being there. That is a service, and it has a cost.
You pay it twice. Buying at the ask and later selling at the bid means crossing the gap on the way in and on the way out. That pair is the round trip, and it is the number that matters.
Nothing guarantees you a good fill. The spread you see is the best available at that instant. A market order takes whatever is there, and if the size you want exceeds what is resting at the best price, you eat into the next level too.
A worked example
On this site’s shared series a round trip costs 0.0098 and the median bar range is 0.493. So one round trip is about 2% of a typical bar.
Now scale it by frequency. One trade a day over 250 trading days costs 2.45 in price terms — about five median bars of range, over a year. Tolerable.
Twenty trades a day over the same year is 5,000 round trips, which costs 49.0 — roughly 99 times the median bar range. The strategy has to find ninety-nine bars’ worth of movement before it has broken even on the spread alone.
The same cost is trivial at a wider target. A trade aiming for two bars of range pays about 1% of its target in spread. A trade aiming for a fifth of a bar pays about 10%. Identical spread, an order of magnitude apart in what it means.
This is why the spread decides which strategies are possible for you, rather than merely making them slightly less profitable. Expectancy works the arithmetic through: below a certain target size the edge is gone entirely to costs, no matter how well the trading is done.
When it widens
The spread is not a constant. It reflects how many people are willing to stand between buyers and sellers right now, so it narrows when participation is high and widens when it drops.
Session overlap is when it is cheapest, and the quiet hours are when it is most expensive — the same instrument, the same broker, several times the cost depending on the clock.
And it widens during exactly the events you would want to react to. When an announcement lands, market makers pull back and the gap opens. The moment the spread is worst is the moment most people are trying to trade, which is not a coincidence — it is the same fact seen from two sides.
The original data
A round trip on this site’s shared series costs 0.0098, which is about 2% of the median bar range of 0.493 and about 1.6% of the median ATR14 of 0.5994.
The figure that surprises people is the frequency multiplier. The per-trade number looks negligible and the annual number does not: 2.45 at one trade a day, 49.0 at twenty — about 99 median bars of range surrendered before any judgement about the market is even tested.
Nothing about that figure depends on being wrong. It is charged identically on winning and losing trades, which is what makes it different from every other thing that costs money in this business.
When it fails
The characteristic failure is comparing brokers on commission while ignoring the spread. A zero-commission account with a wider spread is more expensive than a commission account with a tight one, and the comparison is hard to make because only one of the two numbers is published. The cost that is advertised gets optimised and the cost that is hidden gets paid, which is exactly the wrong way round — and for an active strategy the hidden one is usually the larger.
A second failure is assuming a stop fills at its level. A sell stop triggers and then fills at the bid, which is below it — so the realised loss is consistently a little larger than the planned one.
A third is backtesting on mid prices. Historical data usually stores the midpoint, so a backtest run on it trades at a price that was never available and reports an edge that does not exist live.
A fourth is trading illiquid instruments for their movement. They move more because fewer people are there, and the same thinness that produces the movement produces the spread.
And a fifth is treating it as fixed when planning. A strategy modelled on the tightest spread of the day will meet a different number at the open, at the close, and on every announcement it holds through.
Related
Expectancy covers the arithmetic that decides whether a target is large enough to survive the spread. Volatility covers the bar size the spread is measured against. And stop loss covers why the realised loss is reliably a little worse than the level you chose.
The spread is the cost I underestimated for the longest, because unlike a commission it never appears anywhere you can look at it. It comes out of the fill price, so a losing month looks like bad trading rather than what a good part of it actually was, which is paying to cross a gap several thousand times.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.