What Is A Spread In Cryptocurrency Trading?

Have you ever heard of the spread in crypto trading? While this concept might seem quite tricky to understand, it’s essential to keep it in mind when entering the trading space. Let’s look at spread in more detail to find out what it is, why it’s important, and how it affects traders.

What Is A Spread?

In crypto, a spread commonly means the difference between the bid and ask prices. The bid price is the highest cost buyers are willing to pay, and the ask is the lowest sellers are willing to accept. Simply put, the spread is the gap between the buying and selling prices of an asset, representing the cost of executing a trade.

The simple way to calculate the spread is: Spread = Lowest ask price – Highest bid price.

For example, let’s say the current market prices for Bitcoin are as follows:

• Highest bid price (buying price): $99,000

• Lowest ask price (selling price): $99,100.

So the spread would be: Spread = Lowest ask price – Highest bid price = $99,100 – $99,000 = $100.

If you buy 1 BTC at its selling price of $99,100 and sell it right away, you will only get $99,000, meaning you can lose $100. However, if you wait, the market might change, making the bid price rise to $100,000 and the ask price to $100,100. If you sell 1 BTC at the new bid price of $100,000, your profit is calculated as: Profit = New highest bid price – Original lowest ask price = $100,000 – $99,100 = $900. So, the spread is already accounted for the moment of the first entering the trade. This way, the example shows that understanding and factoring in spreads is critical to accurate profit calculations.

Types Of Spread

There are multiple types of spreads, and every one of each is connected to a certain aspect of the crypto market. Let’s take a look.

1. Arbitrage spread. This type of spread comes from price discrepancies of the same cryptocurrency across different exchanges or markets. Traders exploit 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.

2. Liquidity spread. This type refers to the difference in liquidity levels across various crypto exchanges or trading pairs. Higher liquidity generally leads to tighter spreads, while lower can result in wider spreads.

3. Percentage spread. This is calculated as the difference between the bid and ask price, expressed as a percentage of the asset’s price. This type of spread helps traders quickly assess the relative cost of trading across different assets or exchanges. It is useful for comparing how the cost of trading changes based on the asset’s price, especially in volatile markets.

4. Fixed spread. It remains the same regardless of market conditions, meaning the difference between the bid and ask price is predetermined by the broker. This provides traders with predictable and consistent costs, as the spread does not change with volatility or liquidity. Fixed spreads are commonly found in market maker models where brokers set the price difference to ensure stability.

5. Variable spread. This type fluctuates based 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 seen with ECN or STP 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 Spread Affect Trading?

The spread in crypto trading plays a pivotal role in various aspects of the trading experience, influencing everything from transaction costs to selecting trading strategies. Below are the key factors of crypto trading which are impacted by the spread.

1. Trading costs. The difference between the bid and ask prices represents an implicit transaction cost. When a trader buys at the ask price and sells at the bid price, the spread significantly reduces the potential profit. Also, wider spreads mean higher transaction costs, which can erode profit margins, especially for high-frequency or day traders who execute numerous trades.

2. Liquidity indicator. Spreads are a direct indicator of market liquidity. Tighter spreads generally signify higher liquidity, meaning there are ample buy and sell orders close to the current price. Thus, in highly liquid markets with tight spreads, traders can execute large orders without significantly affecting the asset's price.

3. Market volatility. Spreads often widen during periods of high volatility. Traders may demand higher premiums for the increased risk, leading to larger spreads. Wider spreads, in turn, increase the risk of adverse price movements between order placement and execution, making it crucial for traders to adjust their strategies during volatile periods.

4. Execution efficiency. The spread affects the price at which buy and sell orders are filled. A tight spread ensures that traders get prices closer to the market's mid-price, enhancing execution efficiency. A wide spread, on the other hand, can result in trades being filled at less favorable prices. As a result, they move further away from the market's mid-price, which can reduce execution efficiency and increase transaction costs.

5. Profitability of trading strategies. The strategies rely on capturing small price movements. Tight spreads are essential for profitability, as wider spreads can negate the small gains from each trade. Market makers provide liquidity by placing both buy and sell orders, the spread between which represents the potential profit. Tighter spreads can lead to higher trading volumes but lower per-trade profits, while wider spreads offer higher profits per trade but may reduce trading volume.

6. Slippage and order execution. Slippage occurs when there's a difference between the expected price of a trade and the price at which it is executed. A wider spread increases the likelihood and magnitude of slippage, especially for market orders. In turn, a tighter spread generally reduces them, as there is less discrepancy between the bid and ask prices, making it easier for market orders to be executed at expected prices.

7. Impact on long-term investing. For long-term investors, wider spreads can increase the cost of accumulating (buying) and distributing (selling) large positions in a cryptocurrency, affecting overall investment returns. Regular portfolio rebalancing in assets with wide spreads can lead to higher transaction costs, impacting the net performance of the investment strategy.

The spread is a fundamental component of cryptocurrency trading that affects multiple factors. Traders should consider this parameter when developing their trading plans, selecting exchanges, and managing risk. By understanding and monitoring spreads, traders can make informed decisions and enhance the trading performance.

Did you enjoy reading our article? Was it helpful? Let us know in the comments, and don’t forget to check other crypto-related articles here!