Assets: What is a spread?

All investors encounter order fees, transaction costs, etc. when trading securities and cryptocurrencies. These are explicit costs that you directly notice as an investor. However, many private investors forget the implied trading fees (spreads or spread costs). When buying or selling a stock, deed or ETF on a stock exchange or over-the-counter, there usually comes across two different prices all the time.

How do these different prices arise? Some brokers seem cheaper than their competitors, but why are they so expensive to trade with? This guide will explain it. It also shows that depending on your investment strategy, it may make sense to prioritize higher order fees if your spread costs are very low.

What are spreads?

First, let’s define the term spread. English spread has many meanings, more precisely translation. In this context, the term spread can be translated as margin or difference. From a purely business point of view, this means the difference between two comparable values.

Spread is an important technical term in stock trading. In this guide, we’ll look at price-related spreads, the differences between the buying and selling prices of a security. At the outset, we said that when buying or selling a stock for example, the broker will display two different prices.

Therefore, you should know the following terms:

• Bid price
• Ask price

What is the buy/sell spread?

In this section, we will look at the buy/sell spread, i.e. the bid/ask spread. We will also discuss the factors that affect spreads. First classify the terms. This gives you an overview. Now let’s talk about connections.

Bid and Ask – Supply and Demand

The two prices or rates displayed when a security is traded are called the bid and the ask. The English expression for this is bid and ask. The short form is also sometimes used in stock exchange jargon. Therefore, only bid or ask may be mentioned. The price difference above is called the spread, bid-ask spread, or bid-ask spread. In technical parlance, the ask price is also called the “offer price”.

At first glance, this looks like a lot of jargon. However, it’s easier than you first thought. Now let’s go to the meaning of the term. Basically, you can remember:

• The ask price is higher than the bid price.
• Retail investors pay higher asking prices when buying securities when trading securities.
• If you sell, you receive a lower asking price.
• The spread between two prices is the spread.

Therefore, instant execution allows market participants to receive stocks, ETFs, or other securities at the ask price. If the order is executed immediately, the security can be sold at the bid price. If you buy a stock at the ask price and sell it directly at the bid price, you will lose the spread plus the order fee. Therefore, an investor should pay attention not only to transaction fees, but also to the cost of spreads.

These factors influence propagation

The following factors can affect the bid-ask spread:

• Type of stock
• Exchange trading or over the counter trading (OTC)
• Broker
• The current market situation (volatility)
• Liquidity

Spread cost varies by broker

Of course, spreads vary by deposit provider. Some online brokers have very low spreads but high transaction fees and vice versa.As an investor, you should always make sure your broker has at least standard market spreads. The reference market Xetra provides good direction.

Exchange or over-the-counter

Now let’s talk about the next factor, trading hours. As a rule, spreads are lowest on his Xetra trades, especially in the afternoon. This is due to the following reasons from 15:30 (CEST) American stock exchanges begin trading stocks. This is the time when most trades take place under normal conditions. Over-the-counter or after-hours trading should consider higher spread costs. standard or small cap

Standard stocks or second-line stocks

Of course, the type of securities traded also plays an important role. You can always expect higher bid-ask spreads when trading small-cap or exotic securities than when trading liquid standard stocks. For example, if you trade shares of internationally renowned and popular companies, you can expect low spreads. The same applies to ETFs. Buying small-cap stocks from smaller companies typically results in higher spread costs. Depending on your security, these spreads can be very high. Liquidity and trading volume matter

One of the most important factors is the security’s liquidity. The higher this is, the easier it is to trade. A high trading volume is usually an advantage. Depending on market conditions, turbulent phases may also occur. For example, when an important announcement is pending, we may observe increased volatility. During these phases, there are large price fluctuations. The result is volatile markets and high spread costs.

Bid-ask spread formula

So far, we have discussed what a spread is and the factors that influence the bid-ask spread. Now let’s see how the bid-ask spread is calculated using a simple example.

In the chart below, we calculate the spread for inventory XY.

Suppose stock XY is currently trading at a bid price of $99.70 and an ask price of $100. If you buy directly at the quoted price and do not set a limit, you are buying XY shares at the price of €100. In this case the spread cost is €0.30 or 0.3%.

Absolutely speaking:
Bid-Ask Spread = Ask (Ask) – Bid (Bid) price.

Relatively speaking:
(absolute spread / ask price) * 100 = bid-ask spread in percent.
Even if you want to calculate the total cost, you should include transaction fees. A combination of low order fees and market or low spreads works best.

This scenario assumes a market order that will be executed immediately. Alternatively, you can use limit orders. In this case, we set a limit that must be reached before the order is executed.

What assets are charged with spread costs?

As mentioned earlier, spread costs vary by instrument and broker. Whether you trade stocks, ETFs, mutual funds, commodities, bonds, cryptocurrencies, or derivatives, you incur spread costs. However, depending on the security’s market phase, broker and liquidity, the bid-ask spread has little impact. For liquid stocks, bid and ask prices are about the same – at least under normal conditions.

Spread costs can be very high in cryptocurrencies. Basically, you should always pay attention to the total cost, which is the sum of order fees and spread costs.

What alternatives are there for retailers to spread the cost?

Some providers do not add a spread cost. In this case, investors can trade directly at the market price. These providers are called zero spread brokers. However, if there is no additional spread, the broker charges a trading fee (commission or transaction fee).

In the forex field, we often come across these zero spread models. In forex trading, there are providers who trade in currency pairs (e.g. EUR/USD).

Transaction fees are then applied. For a day trader, he usually trades several times a day, so it becomes all the more important to keep the total cost as low as possible.

You can basically remember:
Brokers make their profits on trading fees or spreads. There is no such thing as completely free trade.

Are there providers that only charge spread costs?

As an investor, if you’re comfortable with market spreads and prefer low order fees, Neobrokers could be an option for you. The following providers charge (almost) no transaction fees.

• Trade Republic
• Scalable Capital
• Smartbroker
• Justtrade

At Trade Republic, he currently pays a fixed fee of €1 per order. The stock savings plan is also free. Smart Broker offers a variety of pricing models.Trading stocks, funds, ETFs and bonds can be done for free via the Gettex trading platform. A prerequisite for this is an order of at least 500 EUR.

Scalable Capital also offers low-cost securities trading. The broker charges an order fee of €0.99 for stock trading. Stock and ETF Savings Plans run free of charge. JustTrade offers stock trading with no order fees, so the only cost is the market spread. However, the minimum order quantity is 500 EUR.

Now ask yourself how these ‘commission free’ or ‘low fee’ brokers are profitable. Neobrokers are paid to place trades (orders) with so-called market makers. Neobrokers like Trade Republic take a commission for transferring orders. In this case, the transaction will only take place via Lang & Schwarz. This model is also called “Payment for Order Flow”.

Brokers with Fixed Trading Fees vs. Spreads

There is no general answer as to which is actually better or cheaper for you.Why not combine the best of both worlds and rely on multiple brokers?

If you’re a buy-and-hold type, i.e. if you buy and then sit idle for years, order fees aren’t that important. should be noted. On the other hand, if you trade a lot, even on a daily basis, you tend to prefer low spreads and trade directly at the market price as much as possible.

In any case, it is always advantageous to keep the total costs (order fees and spread costs) as low as possible.

Don’t be tempted by zero spread offers or zero tariff securities trading. Both have their pros and cons, and both categories have black sheep. Choosing a reputable broker with a fair price-performance ratio is much more important. In addition, you should be able to trade all financial instruments required for your investment strategy.

Finally, I would like to refer to a study that concluded that customers of neobrokers such as Trade Republic are paying the same or lower spreads than Xetra. This does not necessarily mean that trading on Trade Republic is cheaper than trading directly through Xetra.

For example, if you want to trade small caps, other brokers are probably a better choice. Therefore, it makes sense to compare different providers and their portfolios.