On trading exchanges, every market buy and sell settles according to the bid-ask spread – the difference between the highest price a buyer will pay (the bid) and the lowest price a seller will accept (the ask). Limit orders execute at the specified price or better, although execution isn’t guaranteed. Market orders, meanwhile, can be affected by slippage – the difference between the expected price and the actual execution price – which can be substantial in fast-moving markets. The spread changes as the bid and ask move, processing hundreds of thousands of orders throughout the trading day. Here are the factors that can widen the spread and eat into potential profits.
Choice of Broker and Account Type
While the spread is a natural part of an active market, the width of the spread can change depending on which broker and account type a trader uses.
Generally, there are two types of brokers. There are variable spread brokers who follow the market spread accurately, where spreads change more often and are less predictable as a result. Then there are fixed spread brokers who keep the spreads stable during market hours, with a wider but more predictable spread.
No matter what kind of spread is available, some brokers offer zero-commission trading on it. However, zero commission doesn’t mean zero cost, as overnight financing, currency conversion and other charges may still apply, depending on the product and provider. Platforms that offer online trading with fixed spreads often specialise in Forex trading or derivatives like Contracts for Difference (CFDs). Under the provider’s terms, a fixed spread keeps the difference between the quoted buying and selling prices constant – but it doesn’t stop the underlying price from moving, or protect traders against volatility or losses. Some brokers offer both spreads, so a trader can use variable spreads for stocks and fixed spreads for derivatives.
Trading Volume and Liquidity
Over the course of a trading day, the market naturally ebbs and flows with activity. For those trading with variable spreads, this makes the spread narrow when there’s a lot of liquidity and trade volume. Then, when that volume dries up and liquidity runs low, the spread will widen to reflect the bigger impact each new buy and sell has on price action.
Being closely related concepts, traders grappling with a variable spread should understand the difference between volume and liquidity. Put simply, volume measures the amount of an asset traded over a given period, while liquidity describes how easily that asset can be bought or sold without significantly affecting its price. When high volume hits a low liquidity market, thin order books create extreme volatility and order slippage.
News and Market Volatility
Having mentioned volatility, that is the second biggest determining factor in how wide a spread is. While low volume/liquidity can lead to volatility, news and other unexpected events can also spike volatility and move the market in record time. That volatility brings a wider spread, eating into your position entry. Most of the time, volatility disruptions come from outside the market.
Inside the market, high market volatility can be driven by unexpected profit or loss during corporate earnings or other unforeseen actions. Likewise, margin calls/forced liquidations of large market players can create cascading position unwinds that ripple across the market. Away from the market, everything from monetary policy, central bank decision-making (especially the US Federal Reserve), and even geopolitical crises like wars and trade disputes will reflect on the market itself. Naturally, traders should brush up on how macroprudential policies guide the market.
At any one moment, volume, volatility, and a non-stop treadmill of news/press releases dictate the spreads you see on the market. Traders can choose between variable and fixed spreads and can place limit orders if they want their buys and sells to execute at a set price or better – though there’s no guarantee a limit order will be filled.