Why does a spread widen? Let’s try to figure out a widening spread together
WHAT IS A SPREAD? A spread is the difference between the best bid and ask. In other words, the spread is the distance between: - the highest price a buyer is ready to pay; - the lowest price at which the seller is ready to part with a financial asset (futures contract, stock or cryptocurrency). Spreads can be narrow or wide. If someone talks about fixed spreads, it is most likely a forex broker who does not place clients’ orders on a real exchange.
Spreads are usually narrow in popular exchange markets with a large number of buyers and sellers. For example, the price step is 1 cent in the oil market. The spread is practically zero because there are a lot of buyers at $77.15, but at the same time, there are a lot of sellers at $77.16.
Wide spreads occur if there are few buyers and sellers in the market. It is easy to monitor the spread, asks and bids in the ATAS platform using the Depth of Market indicator or a specialized Smart DOM module.
WHY DO WIDE SPREADS OCCUR? The spread width on the stock exchange is a variable value. It should be obvious.
The spread can widen for various reasons. We believe the most common of them are: - Spread widening at night or during the holiday period. When trading activity goes down, the DOM “empties”. The number of buyers and sellers naturally decreases, therefore, supply and demand spread occurs. Fewer trades are made at the price that suits both parties. - Due to order matching algorithms. Order matching is a way (predetermined by the exchange) for buyers and sellers to find each other. It means that orders are matched in a trade. - During high order flow on the exchange, matching algorithms can produce unusual results under extreme conditions — spread widening is one of them. This is possible during the release of important news or breakouts of important levels when the price gets into a cluster of stop-losses. - In unpopular markets. For instance, shares of unknown companies or futures contracts that are far from expiration. - As a result of forex brokers’ manipulations. This does not apply to trading on a centralized regulated exchange. - As a result of technical failures on the exchange. Or due to actions of high-frequency trading algorithms (HFT).
HOW TO IDENTIFY WIDENING SPREADS To identify the widening spread in real time, you can use the market depth indicator in the ATAS platform. The only downside is that monitoring spread changes can seem too tedious and monotonous.
However, identifying the spread on a historical chart seems like a more interesting task. Try switching to non-standard chart types. For example, range charts. When the spread exceeds the range value, you will see characteristic gaps.
You can also try tick charts. A small tick is selected for illustrative purposes, the classic ATR indicator is also added to the chart.
DANGEROUS FEATURES OF THE WIDENING SPREAD The widening spread means that the risk is increasing. If you buy during the widespread, you can only make money if the price passes the entire spread’s width. Widespread = more chances that: - a stop-loss will be activated; - an order will not be executed at the desired price; - you will make a mistake because the decision must be made quickly (unless we are talking about the widening spread occurring at night in an unpopular market).
HOW TO USE THE WIDENING SPREAD IN TRADING First, you need to carefully analyze the history and characteristics of the market. Due to the difference in order matching algorithms and the unique features of each market, spread widening patterns can have a different look. Moreover, spreads may not widen at all or widen very rarely.
Before risking real money, you must make sure that you can earn more than lose in the long run. There cannot be 100% winning trades, but the odds should be in your favor. This is true for any strategy.
HIGH RISK WARNING: Foreign exchange trading carries a high level of risk that may not be suitable for all investors.
Leverage creates additional risk and loss exposure. Before you decide to trade foreign exchange, carefully consider your investment objectives, experience level, and risk tolerance.
You could lose some or all of your initial investment. Do not invest money that you cannot afford to lose. Educate yourself on the risks associated with foreign exchange trading, and seek advice from an independent financial or tax advisor if you have any questions.
Any data and information is provided 'as is' solely for informational purposes, and is not intended for trading purposes or advice.
Past performance is not indicative of future results.