What is the Spread? Why are the Buy and Sell figures different?

Okay, you’ve had a good look around, you’ve taken the tours and everything seems pretty much as it should be. Or is it?

You know how to place a trade, but how do you get out of a trade once it is in place?

Why are the Buy and Sell figures different?

How on earth do you know which direction the market is going to move?

Well, let us consider the Buy and Sell figures first.

In the previous chapter that last screen shot shown was a trade being initiated on the Dow.

Let’s suppose Capital Spreads is quoting a market  ‘Sep 11 Wall Street’ (Dow)* with a BID (Sell) price of 9046 and an OFFER (Buy) price of 9058.

* Sep 11 denotes when the contract that we are trading in is due to end, in this case September 2011. More specifically, the third Friday in September.

If I thought that the Dow was going to drop (go lower) than the BID (sell) price of 9046, then I would BID (Sell) at that price.

Alternatively, if I thought that the Dow was going to rise (go higher) than the Offer (Buy) price of 9058 then I would OFFER (Buy) at that price.

That is easy enough to understand, but why the difference between the Sell and Buy prices?

The short answer is that you are trading something, in this case the Dow, using a middleman, and he makes a profit from the difference between the buying and selling prices, known as ‘The Spread’.

As a quick example, I think the Dow is going to rise. I check the prices and see that the quote is 8490 – 8500. I buy @ 8500 (because I think it is going to go higher). The second that I placed the trade, I am automatically 10 points down (the difference between the sell and buy price) so, should I decide to sell at once, I will lose 10 points.

Anyway sure enough the market does go higher, all the way to 8600. I check the prices once again and see that the quote is now 8590 – 8600.

If I sell now, I will not get the 8600, I will get 8590. The middleman keeps the rest, that’s his profit. Out of his profit comes the smaller spread of who ever he is buying and selling from.

Whenever you make a trade, you will always buy at the higher price and sell at the lower price.

This might sound like a very odd way for a spread betting provider to make a living and a very puny one at that. But the bookmaker (for that is what he is) can never lose.

If you win, he wins, if you lose, he still wins because he keeps part of your losses in the spread. So if you lose £100, he only loses £90 of the £100 you gave him, giving him £10 profit minus the spread he has to pay.

Okay, we have covered why there is a spread, but why is it so big?

The size of the spread has a lot to do with the volatility of the particular object that you are trading and the time scale of the trade.

A daily contract compared to a monthly or quarterly contract will have a relatively small spread, due to the fact that it does not have the capability to move as far (in theory) than that of a longer duration contract. There is less risk involved or so they would have you believe.

What you are actually paying for is the privilege of having a longer period of time to complete your trade.

The same applies to the volatility of a particular object.  The more volatile an object is, the greater the spread.

Having said all of this, as long as you are aware of the spread, it does not really matter. In a perfect world, there would be minimal spread. So if it bothers you that much, find something safe to trade in over a short period of time.

Or shop around at different spread firms.

Now to cover the question of how to stop a trade once it has been placed.

Well, you do exactly the opposite of what you did to place the initial trade. In other words, if you placed a buy trade at £10 per point, to cancel that trade you place a sell trade on the same object for £10 per point.

One trade effectively cancels out the other.

The final question was about knowing when to place a trade. Well we are getting to that bit in the near future, so be patient.

Onwards and upwards!