The Importance of Tight Spreads

What are tight spreads?

A tight spread occurs when there is only a small difference between the price at which you can buy a market and the price at which you can sell that market. Also known as a ‘narrow’ spread, this means that a trader’s cost of trading that market will be relatively low (unless there are other charges).

All traders who have been spread betting or CFD trading for any real length of time can tell you that tighter spreads will make a significant difference when total profits and losses are tallied. The spreads involved when placing your trades should be viewed as the ‘cost of doing business’ in your trading career. Tighter spreads mean that your broker is charging you less for each trade and giving you better value for your money.

What is a spread?

The spread is the difference between the bid price (the price to buy an asset) and the ask price (the price to sell an asset). The difference between these two prices is effectively the amount that your broker is charging you for each trade. When the spread is tight, it means that prices do not need to move far in your forecasted direction before you are ‘in the black’ and starting to make gains.

Intraday trading strategy

Some traders seek to capture small gains quickly and at multiple intervals during the trading session. This method is typically referred to as ‘intraday trading’ and, without cheap trading costs, this type of investment strategy would be almost impossible to implement successfully over the long term.

Intraday traders often look for gains as small as 5 or 10 points, so if a trader is being charged spreads of 4 or 5 points (or higher) it is going to be very difficult for that trader to make any kind of consistent trading income once daily profits and losses are aggregated.

Some longer-term traders consider spreads a negligible cost, using the argument that their trading strategies look to amass much larger gains, sometimes hundreds of points at a time. Some of these traders would suggest that a 1 or 2-point difference in the spread for a trade is insignificant for the most part and that what traders should be most concerned about is the reliability of a broker’s trading platform to execute trades as they are ordered.

There is some truth to this rationale. But it should be clear that, no matter what the trading strategy, higher costs mean higher costs and the individual trader will have to pay these charges. For all of these reasons, it is important to weigh the reliability of the trading platform against the costs charged by the broker and make your choice based on which type of trading style you plan to implement. Higher trading costs are always going to cut into your profit/loss ratio but, if your strategy requires superior execution over shorter timeframes, you might be willing to sacrifice those costs to ensure your trades are properly executed.

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Losses can exceed deposits

Spread betting and CFD trading are leveraged products and as such carry a high level of risk to your capital which can result in losses greater than your initial deposit. These products may not be suitable for all investors. CFDs are not suitable for pension building and income. Ensure you fully understand all risks involved and seek independent advice if necessary.

InterTrader is a trading name of InterTrader Limited which is owned and controlled by GVC Holdings PLC. InterTrader Limited is authorised and regulated by the Gibraltar Financial Services Commission and registered with the Financial Conduct Authority in the UK, ref 597312. Registered address: Suite 6, Atlantic Suites, Europort Avenue, Gibraltar.