What Are Spreads? The Hidden Cost Shaping Your Trades

Traders, especially in the world of crypto, aren’t exactly thrilled about spreads. They’re often seen as the hidden cost of every trade, and yes, they can take a bite out of your profits. In fact, many traders would love to see them disappear. But here’s the twist; while spreads may seem like something working against you, they actually play an important role in creating a balanced, fair trading environment.

Without spreads, financial markets would quickly fall into chaos. For example, in crypto, if spreads didn’t exist, it could lead to market manipulation. Without spreads, traders could exploit tiny price discrepancies between buy and sell prices, executing “buy low, sell high” strategies in mere seconds without any real market movement. This kind of manipulation would destabilize the market, leaving it vulnerable to large scale exploitation. Spreads help prevent this by creating a natural barrier that ensures prices remain reflective of true supply and demand, keeping markets efficient and fair.

So, while spreads may seem like an annoying cost at first glance, they’re actually the backbone of a well functioning market, ensuring transparency, fairness, and liquidity. Understanding how they work can help you change your perspective and who knows, you might even start to appreciate spreads.

What are Spreads?

Spreads, in the financial context, refer to the difference between two prices. Typically, it is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). 

Imagine you are at a bustling marketplace, surrounded by eager buyers and sellers. The bid price represents the highest amount a buyer is willing to pay for a particular asset, while the ask price represents the lowest amount a seller is willing to accept. The spread, therefore, is the gap between these two prices, reflecting the market’s current conditions and dynamics.

Different Types of Spreads

Spreads can take different forms depending on the market, and knowing how they work in each can give you a clearer picture of trading costs and help you manage your strategy better.

1. Bid/Ask Spread (The Most Common)

The bid/ask spread is the most commonly encountered type of spread, whether you’re trading stocks, forex, commodities, or crypto. In liquid markets, such as blue-chip stocks or major forex pairs like EUR/USD, the spread is typically narrow. However, in illiquid markets, such as smaller stocks or exotic currency pairs, the spread can be much wider.

2. Interest Rate Spread

The interest rate spread refers to the difference in rates between two related financial instruments. In banking, this spread is the difference between the rates at which a bank borrows and lends money. For example, a bank might borrow at 1% and lend at 4%, with the 3% difference being its profit margin. This spread also plays a critical role in the bond market, where the difference between the yields of various bonds (such as corporate vs government bonds) helps investors assess the risk associated with different issuers. Credit spreads within bonds indicate the risk investors take on when lending to entities with varying credit ratings.

3. Yield Spread

The yield spread compares the yields of different fixed-income securities, such as bonds. This spread helps investors gauge the relative attractiveness of one bond over another based on returns. For example, a junk bond, with higher risk, will typically offer a wider yield spread compared to a government bond, which is seen as a safer investment. Yield spreads can also signal the health of the economy, with wider spreads often indicating increased risk and narrower spreads suggesting a more stable market.

4. Option Spreads

In options trading, spreads take on a strategic role. Traders use different types of option spreads,  vertical, horizontal, and diagonal, to manage risk and maximize potential returns. A vertical spread involves buying and selling options with different strike prices but the same expiration date. This allows traders to take advantage of price movements while limiting their exposure to risk. Option spreads are commonly used in more advanced strategies, offering traders flexibility in terms of profitability and risk management.

Why Spreads Exist in Finance

You might be wondering, if spreads can sometimes cost you money, why do they exist at all? Well, here’s why they’re actually essential to the functioning of financial markets:

1. Liquidity Provision

Market makers and financial institutions create liquidity by continuously buying and selling assets. The spread compensates them for the risk they take on in doing so. It’s what ensures there’s always a market for you to enter or exit a position. Imagine you are a trader, carefully observing the market’s fluctuations. Spreads act as a barometer, providing valuable information about the market’s liquidity and the level of trading activity. A narrow spread indicates a liquid market, where there is a high volume of buyers and sellers, resulting in minimal price differences. Conversely, a wide spread suggests a less liquid market, with fewer participants and potentially larger price gaps.

 

2. Risk Compensation

The spread also acts as a way to compensate for the uncertainty and risk involved in every transaction. When markets are more volatile or less liquid, the spread widens because there’s more uncertainty about price fluctuations. This applies across all markets, from stocks to bonds to commodities.

3. Market Efficiency

Spreads help maintain market efficiency. They ensure that prices reflect the real supply and demand for an asset. A narrow spread typically signals a liquid market, where buyers and sellers are in close alignment. Wider spreads can indicate market instability or low liquidity, helping traders gauge the overall health of the market.

Factors Influencing Spreads in Traditional Markets

In every market, spreads are influenced by several factors. Here’s a quick breakdown of what impacts spreads in traditional financial markets:

Formula for Spread Calculation:

Spread = Ask Price – Bid Price

This simple formula helps traders understand the real cost of entering or exiting a trade. For example, if a stock’s ask price is $100 and the bid price is $99.50, the spread is $0.50.

Spreads Across Different Markets

Spreads are present in all financial markets, but they play a slightly different role depending on the asset class. Here’s how spreads affect various markets:

1. Stocks

In the stock market, spreads are affected by liquidity and market activity. Large, well-known stocks like Apple or Microsoft generally have narrow spreads because they are heavily traded, whereas smaller, less liquid stocks will typically have wider spreads due to lower trading volume and higher volatility.

2. Forex

In the forex market, spreads vary widely between currency pairs. Major pairs like EUR/USD tend to have narrow spreads due to high liquidity, while exotic pairs like USD/TRY have wider spreads because of lower liquidity and greater price fluctuations.

3. Commodities

Commodities like gold and oil usually have narrow spreads because they are widely traded and liquid. However, agricultural products or less commonly traded commodities often have wider spreads due to less active participation in the market.

4. Crypto

While spreads in the crypto market tend to be wider because of volatility and lower liquidity in some assets, they work similarly to spreads in traditional markets. Spreads reflect the market conditions, so understanding how they function is key to trading effectively in crypto. For more information on how crypto spreads work, refer to our Crypto Spreads article.

Spreads on Morpher

We’ve encountered some feedback from users who have expressed concerns about the spreads on Morpher. As we continuously work on improving the tokenomics of the platform, there are a few important points to address regarding spreads:

Why We Need Spreads for Healthy Morpher Tokenomics—But Don’t Profit from Them

At Morpher, all trades are executed using the MPH token, which plays a central role in our tokenomics. While spreads are a necessary part of trading, we want to clarify that we do not profit from them. Instead, the spreads that are charged on trades help stabilize the MPH token and support the overall health of the ecosystem.

Here’s how it works: When you trade, the spread is immediately burned, effectively reducing the total supply of MPH tokens. This creates deflationary pressure, which is essential for maintaining the value of MPH for token holders. By controlling the supply in this way, we help stabilize the token and ensure its long-term value.

So, while the spread is part of the cost of trading, it’s actually working in your favor by helping stabilize the platform and the value of the MPH token.

High Leverage = High Spread

As with any trading platform, spreads on Morpher fluctuate with market volatility. When users apply leverage up to 10x to their trades, the volume with which they cross the spread increases, effectively raising the cost associated with those trades. The more leverage you use, the more you will pay in spread costs because the market reacts more dramatically to leveraged positions.

Pay Attention to the ⚠️ High Spread Warning

When placing a trade, be aware of the ⚠️ High Spread Warning. This warning indicates that spreads are above 1% for that specific market. It’s a signal to let you know that market conditions are volatile and that trading costs (spreads) might be higher than usual. We provide this warning so you avoid surprises.

How Morpher Helps You Deal with Spreads

While spreads are part of the trading experience, Morpher offers zero-commission trading. This means you only need to account for the spread itself when placing your trades, no extra fees or hidden costs. By focusing solely on spreads, we aim to keep the trading process as simple and transparent as possible.

All Caught Up?

Spreads are a natural part of every market, but now you’re equipped to manage them effectively. While they can’t be avoided, you can navigate them strategically to improve your trades.

At Morpher, we offer zero-commission trading, allowing you to focus purely on the spread—without any extra fees. By recognizing how spreads impact your trades, you can adjust your strategy, reduce costs, and boost your profits.

So, why wait? Sign up today.

Frequently Asked Questions (FAQ)

What are spreads?

Spreads are the difference between bid and ask prices and serve as a measure of liquidity and volatility in the market.

How do spreads impact trading?

Spreads provide insights into supply and demand imbalances, market sentiment, and potential price movements, enabling traders to make informed decisions.

What are the different types of spreads?

The main types are bid-ask spreads, credit spreads, and yield spreads. Bid-ask spreads measure the liquidity of a market, credit spreads assess creditworthiness, and yield spreads compare returns.

What influences spreads?

Market volatility and liquidity play significant roles in spreads. Higher volatility tends to widen spreads, while greater liquidity leads to narrower spreads.

How can I calculate spreads?

Simply subtract the ask price from the bid price to calculate the spread. You can also express spreads as a percentage of the ask price to assess trading costs.

What are some trading strategies involving spreads?

Bull spread strategies involve buying and selling options to profit from rising prices, while bear spread strategies seek to gain from falling prices. These strategies allow traders to manage risk and maximize potential returns.

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Disclaimer: All investments involve risk, and the past performance of a security, industry, sector, market, financial product, trading strategy, or individual’s trading does not guarantee future results or returns. Investors are fully responsible for any investment decisions they make. Such decisions should be based solely on an evaluation of their financial circumstances, investment objectives, risk tolerance, and liquidity needs. This post does not constitute investment advice.