Fixed Spreads And Their Benefits

Lots of traders and investors new to CFDs repeatedly hear the word spread mentioned by their CFD provider and ask me what it means. In short the spread is the difference between the bid and ask price of the CFD. Spreads exist across just about all exchange traded and over the counter (OTC) products however it is not a term frequently used by share traders but more frequently talked about when discussing index and forex CFDs.

The spread of equity CFDs are often the same as the spread of the underlying security on which the CFD is derived however when trading shares this is often known as the bid and ask price. Some CFD providers may widen the spread of share CFDs when there’s a lack of liquidity in the underlying instrument on which the CFD is derived, others may factor their commission charge into the spread. When choosing a CFD broker it is essential that you make sure the spreads of the share CFDs offered are the same as the spread in the underlying equity. Often CFD providers that widen the spread of CFDs over liquid shares as well as charging a fee are earning extra income by profiting from their client’s lack of awareness of the price of the underlying instrument on which the CFD is derived.

Spreads are often applied to Index CFDs. The spreads applied to index CFDs work very differently to the spreads applied to share CFDs for the reason that some CFD brokers will offer CFDs over index futures contracts even when the exchange on which they’re traded is closed. Often the price of an index CFD is derived from the fair value of the futures contract or cash price, CFD providers will take the price of the index and add a spread which is often wider than the spread in the underlying index futures contract. When the exchange on which the futures contract is quoted is closed CFD providers will often widen the spread as they are unable to hedge their customer orders. The spreads applied to index CFDs will vary according to the exchange and liquidity of the underlying futures contract.

The spreads applied to forex CFDs work in a similar manner to the spreads applied to index CFDs however as the forex market is the biggest market in the world, there’s a vast amount of liquidity and spreads are often very tight. It is important to be aware that some CFD providers will take advantage of forex traders by quoting tight spreads for small trade volumes or during quiet market periods, but widen the spread during busy periods or when the trader becomes more active. It is common for CFD providers to differentiate themselves from by quoting variable or fixed spreads, however both have their advantages and disadvantages.

When trading forex CFDs with fixed spreads traders do not have to worry about being re-quoted or spreads widening over periods of high volume, they are also able to calculate their profit or loss accurately without being at the mercy of the CFD provider. Trading forex CFDs on fixed spreads can be advantageous over variable spreads especially during times of volatility where providers offering variable spreads will show exceedingly wide spreads, however trading during times of low volume will cost more. Fixed spreads are often suited to forex scalpers or day traders who trade actively during volatility.

Dealing in forex on variable spreads also provides advantages for the reason that traders are often able to enter the market during quite times at better prices, however all traders should beware that variable spreads are not always advantageous for the reason that should the trader want to exit the position the CFD provider may show a wider spread than the spread shown when the trade was opened. Variable spreads are often better suited to longer term strategy traders who don’t trade during volatile periods.

In conclusion it is vital that as a newbie trader you understand how CFD companies can use the spread to their advantage. As always it is important to make sure that you pick a CFD broker that is able to offer you CFDs that will suit your trading system as the incorrect choice may well be a costly learning experience.

Before you start trading Contracts for Difference you should understand how CFD spreads can impact your CFD trading profits, it is crucial that you consider this prior to selecting a CFD broker.

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