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What is a bid-ask spread?
A bid-ask spread is the difference between the highest price a buyer is willing to pay (bid price) and the lowest price a seller is willing to accept (ask price) for an asset. To better understand what a bid-ask spread is, let’s go into more detail on what bid and ask prices are.
What is the bid price?
The bid price is the maximum price at which traders are willing to buy an asset. This is the price at which you can open a short position (sell) on our platform – it’s always slightly lower than the market price. Bid prices are set by market makers and are influenced by factors like market liquidity and trading volume.
What is the ask price?
The ask price (also called the offer) is the minimum price at which traders are willing to sell an asset. This is the price at which you can open a long position (buy) on our platform – it’s always slightly higher than the market price. Like bid prices, ask prices are determined by market makers and respond to changes in liquidity and trading activity.
Getting back to the bid-ask spread – this is the difference between the bid and the ask price. It represents the transaction cost of trading the asset. Generally, the smaller the spread, the more liquid and actively traded the asset is.
How is the bid-ask spread calculated?
The bid-ask spread is calculated by taking the ask price and then subtracting the bid price. This can be expressed as: bid-ask spread = ask price – bid price. You can also calculate it as a percentage: bid-ask spread (%) = (ask price – bid price) ÷ ask price × 100. Eg if the ask price is £10.05 and the bid price is £10.00, the spread would be £0.05 or 0.5%.
In forex trading, spreads are typically measured in pips. For most currency pairs, a pip is the fourth decimal place, but pairs involving JPY use the second decimal place. For other markets, like stocks and indices, spreads are shown in points or the smallest price increment of that market.
Below, you’ll see a screenshot of the deal ticket for GBP/USD from our platform. On the left is the bid (sell) price of 1.26572 and on the right is the ask (buy) price of 1.26583. In between the two prices, you’ll see the spread of 1.1 pips.
Factors that influence bid-ask spreads
Liquidity
The more liquid an asset is, the tighter (smaller) the bid-ask spread tends to be. This happens because high liquidity means there are many buyers and sellers actively trading, creating more competition and making it easier to execute trades at prices closer to market value.
Volatility
During periods of high market volatility, bid-ask spreads typically widen as market makers increase these spreads to protect against rapid price movements and higher trading risk. This is because sudden price swings make it riskier for them to fulfil their role of matching buyers and sellers.
Quote currencies
Major currency pairs generally have tighter bid-ask spreads than exotic pairs. This is because major pairs like EUR/USD are traded more frequently and have higher liquidity than exotic pairs like USD/TRY.
Trading volume
Higher trading volumes usually result in tighter bid-ask spreads. When more trades are being executed, there’s greater competition among market makers, often leading to more competitive pricing.
Asset class
Different assets have different typical bid-ask spread ranges. Forex majors often have very tight spreads, while individual stocks or exotic currency pairs may have wider spreads due to their specific market characteristics. We discuss this in a bit more detail later.
Time of day
Bid-ask spreads tend to be tighter during UK market hours (8am to 4.30pm GMT) when trading activity is at its peak. Outside these hours, particularly during the Asian session or overnight, spreads may widen due to lower liquidity.
Bid-ask spread across different asset classes
Different markets have specific spread ranges based on their structure and trading patterns:
- Spot markets typically maintain tight spreads, while futures contracts often have wider spreads and are influenced by factors like contract expiration dates and underlying market conditions
- Within the forex market, minor and emerging market currencies may show more significant spread variations than the major pairs
- In the stock market, large-cap shares usually offer narrower spreads than small-cap stocks, reflecting their higher trading frequency and market capitalisation
- Major stock indices like the FTSE 100 or S&P 500 tend to have competitive spreads due to their role as key market benchmarks
- Commodity spreads can vary significantly – widely traded commodities like gold tend to have tighter spreads than niche metals or agricultural products, with energy products like crude oil falling somewhere in between based on market conditions and geopolitical factors
How bid-ask spreads impact your trading costs
Every time you open or close a position, you pay the spread – this is built into the price you trade at. When you buy, you pay the higher ask price, and when you sell, you receive the lower bid price. This means you start each trade at a small loss equal to the spread, which needs to be recovered through market movement in your favour before you can make a profit.
For individuals making multiple trades per day, spreads form a significant part of overall trading costs. A seemingly small difference in spread can have a substantial impact on your bottom line – particularly when trading larger positions or holding multiple positions simultaneously. This is why it’s important to consider the typical spreads of your chosen assets as part of your trading strategy.
Using bid-ask data to refine your trading strategy
Understanding bid-ask data can help you make more informed trading decisions. By monitoring spread patterns, you can identify optimal trading times – for instance, avoiding periods when spreads typically widen, such as during major news releases or market open and close. This is particularly important if you’re trading large positions, where even small changes in spread can significantly impact profitability.
Spread width can also serve as an indicator of market conditions. Unusually wide spreads might signal increased market uncertainty or low liquidity, suggesting you may want to adjust your position size or hold off on entering new trades. Consider incorporating spread analysis into your pre-trade checklist, alongside your technical and fundamental analysis, to help optimize your entry and exit points
