Every trader encounters spreads, whether they trade forex, stocks, or commodities, and it can be a little confusing to deeply understand spread strategies, as the word spreads can refer to multiple things.
Generally speaking, spreads affect the cost of entering and exiting trades, influencing overall profitability. While often overlooked, understanding spreads can help traders reduce trading costs, optimize execution, and even develop trading strategies that take advantage of price differentials.
On top of their role as a transaction cost, spreads are also the foundation of spread trading, a strategy where traders take opposing positions in correlated assets to profit from price differences. (Confused yet?)
This Falcon guide breaks down what spreads are, how they impact trading, and how traders can use spread trading as a strategy.
Understanding Spreads in Trading
At its most fundamental level, a spread refers to the difference between the bid price (the highest price a buyer is willing to pay) and the ask price (the lowest price a seller is offering). This difference represents a cost to traders because they must buy at the ask price and sell at the bid price.
For example, if the EUR/USD currency pair has a bid price of 1.1200 and an ask price of 1.1202, the spread is 2 pips. If a trader buys at 1.1202, they must wait for the price to rise by at least 2 pips before breaking even.
Spreads exist in all financial markets, including forex, stocks, commodities, and cryptocurrencies. However, their size varies based on liquidity, volatility, and the broker’s pricing model.
Key Terms Related to Spreads
Understanding spreads requires familiarity with several key terms that traders encounter across different markets. Below is a reference table explaining important spread-related concepts:
| Term | Definition |
| Bid-Ask Spread | The difference between the bid price (highest price a buyer is willing to pay) and the ask price (lowest price a seller is willing to accept). It represents the transaction cost for traders. |
| Calendar Spread | A trading strategy where a trader buys and sells futures or options contracts on the same asset but with different expiration dates to take advantage of price differences over time. |
| Market Makers | Financial institutions or brokers that provide liquidity by quoting both buy (bid) and sell (ask) prices for an asset, profiting from the bid-ask spread. |
| Futures Spread | A type of spread trading that involves simultaneously buying and selling two futures contracts on the same or related assets to profit from changes in their price difference. |
| Fixed Spreads | A pricing model where the bid-ask spread remains constant, regardless of market volatility or liquidity conditions. These are common in market maker broker accounts. |
| Options Spreads | A trading strategy that involves buying and selling two or more options contracts on the same asset to manage risk, reduce costs, or take advantage of market movements. Examples include credit spreads and debit spreads. |
| Ask Price | The lowest price a seller is willing to accept for an asset in a market. This is the current market price and is always higher than the bid price in a normal market. |
| Debit Spread | A type of options spread where the cost of the long position (buying an option) is higher than the premium received from the short position (selling an option), resulting in an upfront cost (debit). |
| Bid-Ask Price | The two prices quoted for an asset—the bid price (buying price) and the ask price (selling price)—which together form the bid-ask spread. |
Types of Spreads
Different brokers and markets use various spread structures, which impact how traders manage their costs and execution strategies.
Fixed Spreads
- The spread remains constant, regardless of market conditions.
- Typically used by market-maker brokers, who set the spread themselves.
- Provides predictability, but may be higher than variable spreads during low-volatility periods.
Variable (Floating) Spreads
- The spread fluctuates based on market supply and demand.
- Used by ECN and STP brokers, who connect traders directly to liquidity providers.
- Can be lower during high liquidity, but may widen during market volatility.
Commission-Based Spreads
- Some brokers offer zero spreads but charge a fixed commission per trade.
- Common in ECN accounts, where traders receive raw market pricing.
- Can be more cost-effective for traders who execute a high volume of trades.
Strike Prices and Options Spreads
In options trading, spreads are also used as a strategy to manage risk and cost. The strike price plays a crucial role in defining profit potential and loss limits in options spreads.
- Debit spreads – A trader buys an option at one strike price and sells another at a different strike price, limiting risk while reducing upfront costs.
- Credit spreads – A trader sells an option at a higher premium and buys another at a lower premium, collecting the difference as a credit.
- Calendar spreads – Involves options with the same strike price but different expiration dates, profiting from differences in time decay.
- Vertical spreads – A trader buys and sells options with different strike prices but the same expiration date to control risk and define profit targets.
For example, in a bull call spread, a trader might:
- Buy a call option at a $50 strike price (paying a premium).
- Sell a call option at a $55 strike price (collecting a premium).
- If the stock rises above $55, the maximum profit is the difference between the two strike prices minus the net premium paid.
- If the stock stays below $50, both options expire worthless, and the trader loses only the premium paid.
- The strike prices define the trade’s risk and reward, making them critical in structuring spreads.
Each spread type—whether in forex, stocks, or options—has advantages and disadvantages, depending on a trader’s strategy and market conditions.
What Affects Spread Size?
- Liquidity – Assets with high trading volume, such as EUR/USD in forex or Apple stock in equities, tend to have tighter spreads, while less liquid assets have wider spreads.
- Market volatility – During economic news releases or unexpected events, spreads often widen as liquidity providers adjust for increased risk.
- Trading hours – Spreads are generally tighter during peak trading hours when more participants are active and wider during off-hours.
- Broker type – Market makers set their own spreads, while ECN brokers pass on raw spreads from liquidity providers.
How Spreads Impact Trading Strategies
- Scalping and day trading – Traders who execute multiple short-term trades need tight spreads, as frequent transactions amplify costs. Even a slight increase in the spread can affect overall profitability.
- Swing trading – Since positions are held for several days or weeks, spreads are less of a concern, but wide spreads can still affect entry and exit points.
- News trading – Spreads can widen drastically during major news events, making it riskier to enter trades immediately after announcements.
Traders who tailor their strategy to spread behavior can reduce unnecessary costs and improve trade efficiency.
What Is Spread Trading?
Beyond managing spread costs, some traders use spreads as a trading strategy, focusing on price differences between related assets rather than absolute price movements.
How Spread Trading Works
Spread trading involves buying one asset while simultaneously selling another related asset to profit from the price difference between the two. The goal is to capitalize on relative price movements rather than market direction.
Types of Spread Trading
- Intermarket Spread – Trading two related assets from different markets, such as crude oil and natural gas.
- Intramarket Spread – Buying and selling contracts of the same asset with different expiration dates (common in futures trading).
- Intercommodity Spread – Trading correlated commodities, such as gold and silver or corn and wheat.
- Forex Spread Trading – Taking opposing positions in correlated currency pairs, such as going long on EUR/USD and short on GBP/USD.
Why Traders Use Spread Trading
- Lower volatility risk – Because traders hold offsetting positions, spread trading can help reduce exposure to large market swings.
- Capital efficiency – Some brokers offer lower margin requirements for spread trades, allowing traders to manage larger positions with less capital.
- Market-neutral opportunities – Spread trading can be effective in uncertain markets, where outright directional trades carry higher risks.
While spread trading offers strategic advantages, traders must carefully analyze correlation, liquidity, and external factors that influence spread behavior.
How to Minimize Spread Costs
Even if traders don’t use spread trading as a strategy, they can still take steps to reduce the cost of spreads in regular trading.
- Trade during high-liquidity hours to access tighter spreads.
- Use an ECN broker to benefit from lower spreads and raw pricing of the underlying asset.
- Avoid trading around major news releases, when spreads can widen unpredictably and likely outside of your risk tolerance.
- Choose the right account type based on trading style—fixed spread, floating spread, selling options, or commission-based.
Final Thoughts
Spreads are a fundamental (albeit complex!) part of trading, affecting everything from trade execution costs to overall profitability.
For traders getting started on their prop firm journey, navigating the complex world of trading terminology and strategies can be challenging. At Falcon Funded, we provide world-leading support for our new traders, teaching them the fundamentals of trades and supporting them as they earn their first payout and beyond.
If you’re ready to get started with trading via the most trusted prop firm platform, start your trading journey here.
