Are you new to cryptocurrency trading and want to learn the fundamentals before getting started? Or maybe you’ve bought and sold crypto before but aren’t quite sure what market spreads are and their influence on the price.
Either way, it’s important to understand the basics of market spreads. They directly affect the total cost of trading and can give you an insight into essential market factors.
Market spread
Market spread can tell us a lot about an asset. Successful traders and investors need to know what spreads are and how they can use them to influence trading strategies.
What is spread?
A market spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price that a seller will accept (ask).
Spreads are essentially transaction costs that go to the market maker. Since they buy at the ask price and sell at the bid price, they take home the resulting profits in exchange for facilitating the sale.
Spreads tell us about the liquidity of a market because they directly represent the supply and demand for assets. We’ll discuss this in more detail below.
How is spread calculated?
Spread is calculated by a very simple formula. All you need to do is subtract the highest selling price from the lowest asking price.
Spread = Lowest Asking Price - Highest Bidding Price
To calculate spread as a percentage: (Spread / Lowest Asking Price)*100
To give an example, let’s say you wanted to buy some Bitcoin (BTC). You visit your favourite crypto exchange and see that the lowest asking price is $55,000, and the highest bidding price is $53,000. This means the spread is $2,000.
$2,000 = $55,000 - $53,000
The spread will not always be this large. For cryptocurrencies denominated in smaller amounts, the spread might only be a fraction of a dollar.
That’s why it’s helpful to calculate spread as a percentage when you’re comparing two different spreads with vastly different price ranges.
For example, let's calculate the spread as a percentage for the example above. First, take the spread and divide it by the lowest asking price. Then multiply that number by a hundred.
2,000 / 55,000 = 0.036
0.036 * 100 = 3.6%
So, the spread in this example is either $2,000 or 3.6%. You could use these numbers to compare the spread to another cryptocurrency or financial asset.
What does spread represent?
To put it in the simplest terms, spread is a good representation of market liquidity.
· High spread = low liquidity
· Low spread = high liquidity
Those who initiate transactions demand liquidity, while market makers supply liquidity. Some markets are more liquid than others and have lower spreads.
For instance, the forex market is the most liquid in the world. Since the transaction volume is so high, spreads are often less than a hundredth of a percent. So, when you place a market order in the forex market, the final sale price might only shift a fraction of a dollar. On the other hand, small-cap stocks are not as liquid. The spread might be as much as 1% or 2% of the lowest asking price.
Cryptocurrency is harder to define in these generalizations. Liquidity in crypto is determined by the demand for individual cryptocurrencies and the specific crypto exchange.
For example, cryptocurrencies with high market caps are more liquid than those with low market caps. There is an incredible demand for cryptocurrencies like Bitcoin, Ethereum, and Tether. They all have daily trading volumes in the billions of dollars. This means that you will have no problem finding a buyer or seller at the market price.
In contrast, smaller-cap altcoins may not have high trading volumes, and your trade may not execute at the market price you desired.
In terms of exchanges, liquidity depends on the number of users and their activity on the platform. If there are many users placing orders, then there will be higher liquidity and lower spreads. On the other hand, if the exchange has a low trading volume for certain cryptocurrencies, the liquidity will be low, and you’ll notice higher spreads.
In addition, high spreads can indicate other factors such as market manipulation or breaking news about an asset.
How does spread impact the cost of a trade?
Market spreads directly impact the cost of a trade. For example, high spreads can be unprofitable due to slippage.
If you don’t know what slippage is, it refers to situations where you receive a different trade price than intended. For example, let’s say the current best ask price for 1 BTC is $50,000. You place a buy order at $50,000 expecting to purchase 1 BTC.
However, when the trade executes, you only receive 0.95 BTC. In this case, you experienced slippage. Due to market transactions before your order was filled, the best ask price increased slightly, and you paid a higher amount than intended.
As you can see, slippage can significantly affect the cost of a trade. This is especially true when it comes to situations with low liquidity. If low liquidity results in a high spread, market movements can increase the slippage rate.
On the other hand, high liquidity lowers the slippage rate because your order is more likely to be executed at or near your desired bid price.
Spread between various assets
When comparing spreads between various assets, such as BTC to ETH, it can be easy to misread the information.
Since they have significantly different price scales, you should always index the price series to measure the spread more accurately.
If two cryptocurrencies move similarly in the market, then they have a low spread, and it suggests that similar factors influence them.
On the other hand, if two cryptocurrencies move differently in the market, they have a high spread. The same factors may not influence them.
This type of spread analysis can be helpful for comparing crypto assets and how they react to specific market conditions.
Are there trading strategies for spread?
Yes, analyzing spread can have a direct impact on your trading strategy. While it won’t necessarily tell you if an asset will be a profitable investment, it does play a role in how you approach individual trades.
Most traders look for low spreads because it can be easier to turn a profit. Low spreads indicate that an asset has a lot of buyers and sellers competing for the best prices. On the other hand, high spreads indicate a lack of market activity and require the asset to increase in price by more to make a profit.
For example, let’s say that you were to purchase 1 BTC for $55,000, and the spread was $2,000, or 3.6%. You would need to wait for the bid price to increase more than $2,000 in order to sell your BTC for a profit.
On the other hand, let’s say you purchased a different cryptocurrency at the same price with a far lower spread of 0.5%. Since the spread is so much lower, you would only need to wait for the highest bid price to increase more than $275 to make a profit on your initial investment.
So, take a look at the spreads for the crypto you want to purchase on your exchange. Lower spreads make it easier to gain profits over time.
Understanding total fees of crypto trading
Many people just consider transaction fees when it comes to crypto trading. However, spread fees also should be considered.
Exchange fees and spread fees
Exchange fees are different depending on the exchange that you use. Most exchanges charge fees for deposits, withdrawals, transfers, and buying or selling. These usually range from 0.1% to 5% or more.
Spread fees are often not as apparent because they may depend on the trading pair. For frequently traded pairs, the spread tends to be lower.
Comparing fees across exchanges
Some trading platforms advertise zero-fee trading. However, these platforms might use high spreads to compensate for the lack of transaction fees. In addition, these spreads may not be evident at first glance.
It’s recommended to take a close look at the spread range offered by your crypto exchange of choice. Take into account the total trade cost between a platform with no fees but high spreads and one with trading fees and low spreads.