What is a spread?
In cryptocurrencies, the spread usually refers to the difference between the buy price (#BID ) and the sell price (#ask ). The buy price is the highest amount that buyers are willing to pay, and the sell price is the lowest amount that sellers are willing to accept. Simply put, the spread is the gap between the buy and sell prices of an asset, representing the cost of executing the transaction.$BTC
A simple way to calculate the spread: Spread = Lowest selling price – Highest buying price.
For example, let's assume that the current market prices for Bitcoin are as follows:
Highest buying price (buy price): $99,000
Lowest selling price (sell price): $99,100.
Thus, the spread will be: Spread = Lowest selling price – Highest buying price = $99,100 – $99,000 = $100.
If you buy 1 BTC at a selling price of $99,100 and immediately sell it, you will only receive $99,000, which means a loss of $100. However, if you wait, the market may change, and the buying price may rise to $100,000, and the selling price to $100,100. If you sell 1 BTC at the new buying price of $100,000, your profit is calculated as follows: Profit = New highest buying price – Initial lowest selling price = $100,000 – $99,100 = $900. Thus, the spread is already accounted for at the moment of the first entry into the trade. This example shows that understanding and accounting for spreads is critically important for accurate profit calculations.
Types of spreads
Arbitrage spread. This type of spread arises from price discrepancies of the same cryptocurrency on different exchanges or markets. Traders take advantage of these differences by buying the asset at a lower price on one platform and selling it at a higher price on another, profiting from the spread.
Liquidity spread. This type refers to the difference in levels of liquidity on different cryptocurrency exchanges or trading pairs. Higher liquidity usually leads to narrower spreads, while lower liquidity can result in wider spreads.
Percentage spread. It is calculated as the difference between the buying and selling prices expressed as a percentage of the asset's price. This type of spread helps traders quickly assess the relative cost of trading between different assets or exchanges. It is useful for comparing how the cost of trading changes with the asset price, especially in volatile markets.
Fixed spread. It remains unchanged regardless of market conditions, meaning that the difference between the buying and selling prices is predetermined by the broker. This provides traders with predictable and stable costs, as the spread does not change with volatility or liquidity. Fixed spreads are typically found in market maker models where brokers set the price difference to ensure stability.
Variable spread. This type changes depending on market conditions such as liquidity and volatility, widening during periods of high volatility and narrowing during stable times. This type of spread is often observed with direct market access brokers, where traders have direct access to the market. Variable spreads offer flexibility but can lead to higher costs during volatile market events.
How does the spread affect trading?
The spread in cryptocurrency trading plays a key role in various aspects of the trading experience, affecting everything from transaction costs to trading strategy selection. Below are the main factors of cryptocurrency trading that the spread influences.
Trading costs. The difference between the buying and selling prices represents implicit transaction costs. When a trader buys at the selling price and sells at the buying price, the spread significantly reduces potential profit. Additionally, wider spreads mean higher transaction costs, which can reduce profit margins, especially for high-frequency or day traders who make numerous trades.
Liquidity indicator. Spreads are a direct indicator of market liquidity. Narrower spreads usually indicate higher liquidity, meaning there are enough buy and sell orders close to the current price. Therefore, in highly liquid markets with narrow spreads, traders can execute large orders without significantly impacting the asset price.
Market volatility. Spreads often widen during periods of high volatility. Traders may demand higher premiums for increased risk, leading to larger spreads. Wider spreads, in turn, increase the risk of adverse price movements between placing and executing orders, making it critically important for traders to adjust their strategies during periods of volatility.
Execution efficiency. The spread affects the price at which buy and sell orders are executed. A narrow spread ensures that traders receive prices closer to the average market price, improving execution efficiency. A wide spread, on the other hand, can result in trades being executed at less favorable prices. As a result, they move further away from the average market price, potentially reducing execution efficiency and increasing transaction costs.
Profitability of trading strategies. Strategies are based on capturing small price movements. Narrow spreads are essential for profitability, as wider spreads can negate small profits from each trade. Market makers provide liquidity by placing both buy and sell orders, with the spread between them representing potential profit. Narrower spreads may lead to higher trading volumes but lower profit per trade, while wider spreads offer greater profit per trade but may decrease trading volume.
Slippage and order execution. Slippage occurs when there is a difference between the expected trade price and the price at which it is actually executed. A wider spread increases the probability and magnitude of slippage, especially for market orders. In turn, a narrower spread typically reduces slippage since the difference between the buying and selling price is smaller, facilitating the execution of market orders at expected prices.
Impact on long-term investments. For long-term investors, wider spreads can increase the cost of accumulation (buying) and distribution (selling) of large positions in cryptocurrency, affecting the overall return on investments. Regular rebalancing of a portfolio in assets with wide spreads can lead to higher transaction costs, which impacts the net return of the investment strategy.
The spread is a fundamental component of cryptocurrency trading that affects many factors. Traders should consider this parameter when developing trading plans, choosing exchanges, and managing risks. By understanding and monitoring spreads, traders can make informed decisions and improve their trading efficiency.
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