So, why is this called spread trading? As we described before, instead of buying an actual share or commodity at a specific price, you are simply trading the price movement of that stock or commodity. The spread is the difference between the current price market traders will give you if you sell the stock (the Bid price) and how much they’ll charge you if you want to buy (the Ask price). In spread trading, the difference is a little larger, because it is derived from the underlying stock’s regular bid/ask spread (thus qualifying it as a derivative) plus adding in a small difference which is your spread trading company’s charge or commission.
But while your spread in spread trading will be slightly higher than a regular bid/ask spread, because you’re not buying the stock or commodity, but rather a derivative of it, you don’t pay any Capital Gains Tax, Stamp Duty, or Income Tax on dividends which more than compensates for the difference.
An example of a spread:
Let’s say the price of NEXT share is currently 1212p. The ‘spread’, or the ‘bid‐offer’ quote for a share like NEXT may be 1211 – 1213. The 1 pence on either side represents the commission the Spread Trading company earns. So then you decide whether NEXT’s price is going to go below 1211 in a certain amount of time, or whether it goes up over 1213.
If you think the share will go down, below 1211, you sell.
If you think the share will go up, above 1213, you buy.
If you’re buying a quarterly rolling contract such as an NEXT May contract (and let’s say you make the trade in March), there will be an even larger spread, or an extra premium, which factors in the cost of the trading company financing your trade from May to March. This premium is often called the cost of carry.
The Spread Can Change
It’s important to know that the spread for a particular share or commodity changes along with a change in the price of the underlying share or commodity. Let’s say that you took a look at NEXT in the morning and it was 1212p, but you decided not to trade it right then. Later in the afternoon, NEXT has risen to 1220p a share. The spread will change with that change in price, and would then be something like 1219 ‐ 1221.
The spread changes as quickly as the price of the share or commodity changes. In volatile markets like 2008’s, the spread can be vastly different in just a couple of hours. Financial news released during the day like a report on unemployment, or the announcement of a central bank changing interest rates can make the changes in the spread even more dramatic.
Also it is worth remembering that the spreads are generally much larger outside market trading times and on market opening – be aware of this.
Finding the Best Deal on a Spread
The amount of difference between the bid and ask spread can vary between one spread trading company and another. The closer the bid or ask is to the actual price of the stock or commodity, that is the smaller the spread is, the better deal it is for you. With NEXT trading at 1212p one company’s spread may be 1211 ‐1213, but another company’s may be 1210 ‐ 1214. You are basically paying that second company more in commission.
An example of what that difference between companies means to your profits or losses:
Let’s say you place a trade to buy NEXT when it is 1212p. You place your order with the COMPANY ABC whose spread is 1211 ‐ 1213. You decide to trade £100 per point movement in the price. Remember, your buy price isn’t 1212 but 1213, because of the spread. NEXT then goes up from 1212 to 1220. You decide to sell at 1220.
With COMPANY ABC, you would make £700 because you bought at 1213 and it’s gone up 7 points, which means you make £100 X 7 (£700).
COMPANY XYZ’s spread is 1210 ‐ 1214. So when NEXT goes up from 1212 to 1220 as above, you would only make £600, because you bought it at 1214 with COMPANY XYZ. Therefore 1220 – 1214 = 6 points. 6 x £100 per point = £600.
That’s £100 less you would make compared to the first company’s smaller spread.
Why do some Spread Trading Companies have a Larger Spread than Others?
There are many reasons for this, sometimes it can be because you are paying more for better services. Some of the advantages of a company with higher premiums could be:
- more “products” (such as foreign stocks, a wide range of indexes, lots of different commodities, etc.)
- faster trade executions
- more types of orders you can use (especially different types of stop‐loss orders)
- better customer service and after‐hours support if you have questions or problems
- margin requirements
- paying interest on the money you have in the account, just as you get with savings account.
- incentives for example they may offer extra credit to your account or access to online streaming data for your custom