Understanding spreads in Forex trading: Real impact on your results

What is the role of spreads in trading?

Spreads represent the most direct implicit cost faced by operators in derivatives markets. It is the difference between the offer price (Ask) and the demand price (Bid), that is, what we pay to buy versus what we receive when selling a given asset.

This gap is not arbitrary. Its width depends on factors such as the asset’s volatility, market depth, transaction volume, and current economic conditions. Understanding this mechanism is essential for any trader seeking to optimize profitability, as each operation automatically incorporates this cost into the execution process.

The mechanics of the spread: Calculation and types

How to calculate the spread in practice

The calculation is straightforward: subtract the Bid price from the Ask price. For example, in the EUR/USD pair, if we observe a quote of 1.05656 (Bid) and 1.05669 (Ask), the spread would be 1.3 pips, considering that in Forex each pip corresponds to the fourth decimal.

Spread = Ask – Bid = 1.05669 – 1.05656 = 0.00013

Two fundamental classifications

Dynamic spreads: They adjust continuously according to market conditions. Their width fluctuates with volatility, volume, and available liquidity depth. They are standard on modern platforms thanks to technology that allows real-time information transmission.

Static spreads: They maintain fixed values established beforehand, although they can widen significantly during periods of extreme volatility or low liquidity.

Direct impact on your trading profitability

A high spread directly consumes part of your potential profit. Investing in assets with narrower spreads improves our profitability thresholds from the outset. Conversely, wide spreads reduce the available margin for maneuver.

It is essential to recognize that the spread acts as an embedded transactional cost. While traditional financial institutions charge explicit and separate commissions, derivatives brokers incorporate their remuneration within this price gap. This means that your net profit already accounts for this component from the moment you execute the order.

Factors that determine the width of spreads

Market volatility

Markets with pronounced movements present wider spreads. Cryptocurrencies or small-cap stocks exemplify this clearly, with significantly larger gaps than monetary instruments where percentage changes are moderate.

Available liquidity

Assets with deep markets (such as major Forex pairs: EUR/USD) enjoy reduced spreads. In contrast, less traded or exotic instruments like NZD/CAD experience significantly larger spreads. Comparing daily transaction volumes reveals the pattern: Apple and Amazon, traded hundreds of millions daily, have very low spreads, while less traded stocks can be considerably wider.

Impactful news events

Relevant economic announcements, geopolitical conflicts, or monetary policy decisions can temporarily widen spreads. When Russia invaded Ukraine, the spreads of pairs with the ruble surged. Similarly, major changes in issuing economies generate spread expansions.

Forex spread trading versus stock markets

The concept of pip and tick

In Forex, we measure the spread in pips due to their precise decimal variations. In stocks, where quotes operate with wider decimals, we use the minimum trading unit called “tick.” In U.S. markets, each tick typically equals 0.01 dollars.

Practical example in stocks

For a CFD operation on Microsoft with Bid price of $329.61 and Ask of $330.33:

Spread = 330.33 – 329.61 = 0.72 ticks (or 72 cents)

Here, we do not express the result as pips, since 72 pips would represent just 0.0072 dollars, an amount that does not match the operational reality of this market.

Advanced strategies using financial options

Proper spread trading strategies operate through options, not ordinary CFDs. Options are derivative contracts that grant rights (but not obligations) to buy or sell at a predetermined (strike) price on a future date, requiring the payment of a premium.

The three main modalities are:

Vertical spreads: Buying options with the same expiration but different strikes, allowing to limit exposure while moderating risk.

Horizontal spreads: The strike remains constant while expirations vary, exploiting different time decay.

Diagonal spreads: Both strikes and expirations diverge, providing maximum strategic flexibility.

These combinations of buying and selling Calls and Puts are structured according to bullish, bearish, or lateral consolidation perspectives.

Final reflection on spreads in derivatives

Spreads are unavoidable components of any derivatives trading, whether Forex, stocks, or other assets. A deep understanding is a prerequisite to optimize sustainable results. The key lies in choosing platforms that maintain full transparency in their cost structures, avoiding hidden commissions or unexpected additional expenses that could erode the profitability achieved in the market.