While most traders find the term “price spread” meaningless when it comes to how it affects their overall portfolio, it is essential to understanding how the market works as a whole. This is because it affects the liquidity, volatility and price of cryptocurrencies.
In this article, we will discuss:
What is Spread Trading?
Spread is the difference between the highest bid and the lowest ask in an order book. In simpler terms, it is the difference between the price people are willing to buy an asset at and the price people are willing to sell an asset at. For example, let's say you want to buy Bitcoin. You can tell the seller that you are willing to pay $37.000 for a Bitcoin. However, the seller may respond to your offer by saying that he will not sell Bitcoin for anything less than $40.000. The difference between your bid to buy Bitcoin for $37.000 and the seller's offer to sell Bitcoin for $40.000 is called the trade spread.
How does Spread Trading work?
In an order book, the most prominent are the following three prices:
- The highest bid price.
- Lowest sale price.
- The last price traded.
As discussed, the difference between the bid price and the ask price is the spread. Even though the last trade was made at a specific price, it does not mean that a trade will take place at the same price. A big difference between the bid price and the ask price is often related to low liquidity order backlogs. As each crypto exchange has its market, some may contain more liquidity than others, thus representing an arbitrage opportunity.
Furthermore, a spread reflects the difference in perceived value of the asset. Along with this are traders and investors who want to make a profit, which is why the price fluctuates. It is what makes average market prices possible and allows users to make quick trades at “market price”.
How to calculate the trading spread?
Now that we've covered the concept, it's equally important to know how to calculate the trading spread.
For example, if we are on an exchange for the BTC / USDT at any time, the lowest Bitcoin ask price is $39.184,93 and the highest bid is $39.184,92. To calculate the spread, all we need to do is deduct the highest bid price from the lowest ask price.
Spread = order price - bid price
Spread = $x - $y
= $39.184,93 - $39.184,92
= $0,01
Therefore, $0,01 represents the spread, which is essentially the price difference between the asking price and the asking price.
The impact of commercial propagation on the cryptographic market
Trading spreads affect the liquidity and price volatility of a market. The less liquid a market is, the higher its average price and vice versa. The liquidity of a market is the price at which an item / asset can be sold or bought in that market instantly without affecting its price. Therefore, in case of high liquidity, the purchase is more likely to reduce the price of an item, as the trading spread would be smaller in a high liquidity market.
Furthermore, spreads are responsible for increasing the price volatility of a crypto asset. For example, if the Bitcoin price on one cryptocurrency exchanger is higher than on other exchangers, traders will start buying it on those platforms. Bitcoin can then be sold on the exchanger where the price is highest to make some profit. This will result in an eviction, causing the Bitcoin price fall down.
Benefits and risks of spread trading
Benefits of Spread Trading
Spread trading presents arbitrage opportunities for investors and traders. A price spread can be leveraged by buying an asset at a lower price on one Exchanger and selling it on other Exchangers. Popularly known as arbitrage trading, it has been taken advantage of by smart traders who know how to benefit from price spreads. However, an investor must transfer these funds before their prices are reached between certain Exchangers.
Spread Trading Risks
While spread trading looks attractive, it is not bulletproof and carries risks. First, traders must know how to identify correlated cryptocurrency pairs. This means they must understand its market value and price movements. Second, time is of the essence. An underlying pair needs to be liquid enough that a trader can act instantly when the price gap disappears. Finally, although the cryptocurrency market is highly volatile, there is no guarantee that the price will reconvert. Costs may or may not correlate again. All investments carry risk and cryptocurrencies are even more volatile than the stock market.