The difference between the buying price and selling price is one of the key costs of trading. Unlike the direct commission costs, spreads are a hidden cost of trading CFDs. Some brokers offer fixed spreads, allowing you to easily assess their impact in advance, while others will insist on variable spreads, and you will not know how much they are until the time comes to trade.
Simply put, spreads are the difference between the price that you can buy at, and the price that you are able to sell at, and they may vary among CFD providers; much like commission there is not one standard spread all providers charge. As soon as you buy, you have lost money, as you can only sell back at a lower rate – this is the impact of the spread. Your trade must move in the appropriate direction a certain amount before you can even break even, and that certain amount is the spread..
Make sure your provider offers competitive spreads for the market you intend to trade. For this reason it is good to shop around and find which CFD provider offers the tightest spreads and the lowest deposits. It’s not the only thing you should consider though.
It is often said that the bid-offer spread is the active trader’s biggest enemy, and the one over which he has least control. Obviously, the smaller the spread, the quicker your trade will come into profit and the more money you will make. Therefore it would seem a priority that your account should be held with the broker who offers the smallest spread. That is only one part of the cost of trading however, and must be considered along with the financing cost that CFD providers charge for holding positions overnight. It makes sense to look at all the applicable charges and take into account that most providers will not pay you as much interest on your free cash as you would get from a bank.
Generally CFD providers will charge you fees for the following -:
- Holding a Position Overnight (financing)
- Exchange Data
- Transaction Fees (commission)
- Trading Platform
- Negative Account Balances
Spreads can also vary from provider to provider but they also vary depending on the product offered. Usually, spreads are only relevant to index and foreign exchange CFDs. Crossing the spread is basically the same as paying a commission, this is how CFD providers makes money from their clients trading activity.
It is not easy to clearly identify the broker with the smallest spreads. The spread will vary depending what is being traded, and the “best” spread for a Forex based CFD may be offered by one broker, while another CFD provider has a better spread on index products. You will need to undertake an amount of research if you want to be certain that you have got the best deal for your money.
Fixed Spreads or Variable Spreads?
As we have already noted, some providers are split in their provision of fixed or variable spreads. Whether a fixed or variable spread is offered will also point to the type of broker that they are. Typically those offering a fixed spread must be market makers, as it is imposing a discipline on the prices that the market itself does not. With Direct Market Access (DMA) you will find that the prices seek their own level, and the spread will vary.
Fixed spreads, naturally offer more stability while variable spreads increase and reduce according to market depth, or liquidity. Usually during busy times, especially for forex markets, you can expect to see the smallest spreads, and if you trade out of major market trading hours, where available, then there is less liquidity, less activity, and the spreads will open out. You can also see spreads widen in anticipation of a fluctuating price, for example just before news releases. However, beware that spreads may widen significantly in times of low liquidity or around data releases.
In terms of trading costs, tight spreads are definitely important but you have to be careful to compare ‘apples to apples’. When you are shopping around to find a broker, you may want to observe what their spreads are over a period of days. It is quite common for a broker to claim that he has low spreads in order to attract the business, but it is only by watching how they vary during regular trading that you will see what they average in practice. For instance some providers may boast of ‘spreads from 0.9’, but such bid-offer spreads may only be available when the market is doing nothing which isn’t really any good. Instead of judging a CFD provider on its advertised spreads, which are simply a starting point before volatility kicks in and drags them wider, try to observe them particularly around the times that you expect to do your trading like say over the course of a day.