Bid-Ask Spread: How Spreads Affect Your Trading Costs

What Determines Spread Width

Liquidity: Highly liquid markets like S&P 500 ETFs, major forex pairs, and large-cap stocks have tight spreads because many buyers and sellers compete for the same securities. An S&P 500 ETF like SPY might have a 1-cent spread on a $500 share price -- 0.002%. Illiquid stocks, small-cap companies, and exotic forex pairs can have spreads of 1-5% or more.

Volatility: During periods of high volatility, spreads widen because market makers face greater risk of adverse price movements. Earnings announcements, economic data releases, and market-opening and closing periods typically see wider spreads. During the March 2020 COVID crash, even typically tight markets saw spreads widen 5-10x normal levels.

Time of day: Spreads are tightest during the main trading session when volume is highest. Pre-market, after-hours, and overnight trading sessions have lower liquidity and wider spreads. The first and last 15 minutes of the trading day also tend to have wider spreads due to increased volatility. Optimal trading hours to minimize spread costs →

Spread Costs by Asset Class

Stocks: S&P 500 stocks typically have 0.01-0.05% spreads. Small-cap and micro-cap stocks can have 0.5-5% spreads. Penny stocks often exceed 5%.

Forex: Major pairs (EUR/USD, USD/JPY, GBP/USD) have 0.5-2 pip spreads -- about 0.005-0.02% for EUR/USD. Exotic pairs (USD/TRY, USD/ZAR) can have 5-50 pip spreads -- 0.05-1%.

ETFs: Popular ETFs like SPY, IVV, QQQ have spreads similar to large-cap stocks (0.01-0.03%). Niche ETFs with low trading volume can have spreads of 0.2-1%.

Options: Option spreads are wider because each contract is unique (strike price, expiration date). At-the-money options on liquid stocks might have 0.05-0.10% spreads, while far out-of-the-money or illiquid options can have spreads of 5-20% or more.

Bonds: Corporate bonds trade over-the-counter with dealer spreads that can be 0.5-2% for investment-grade bonds and 2-5% for high-yield bonds. Government bonds (Treasuries) have much tighter spreads of 0.01-0.05%. Bond spreads and their impact on fixed-income returns →

Calculating Spread Costs

Spread cost per round-trip = (ask - bid) / midpoint * 100%. A $10 stock with $10.00 bid and $10.01 ask has a spread cost of 0.1% per side, or 0.2% round-trip. On a $10,000 position, that is $20 per round-trip. For an active trader making 50 round-trips per month, spread costs alone are $1,000/month -- 12% annualized of the $10,000 position. This is why high-frequency traders care about fractions of a penny, and why swing traders or position traders who trade infrequently have a structural cost advantage. The more frequently you trade, the more spread costs eat into your returns, regardless of whether your trades are profitable on a gross basis.

How to Minimize Spread Costs

Use limit orders instead of market orders to avoid paying the full spread on every trade. Trade liquid instruments -- stick to the most actively traded stocks, ETFs, and forex pairs. Trade during peak hours when spreads are tightest. Avoid illiquid securities, penny stocks, and exotic currency pairs. Consolidate your trades into larger blocks rather than making many small trades. Use brokers with commission-free trading and look for those that offer rebates for providing liquidity (taking the bid or offer rather than crossing the spread). For forex, use ECN accounts that offer raw spreads plus a small commission -- these often result in lower total costs than dealing desk models with wider spreads. Factor spread costs into position size calculations →

What is a good bid-ask spread?

A good bid-ask spread depends on the asset class. For large-cap stocks and major ETFs, a spread under $0.01 (0.01-0.03%) is excellent. For forex majors, under 1 pip (0.01%) is good. For small-cap stocks, under 0.5% is reasonable. For options, under $0.10 (0.5%) on a $20 option is decent. The spread is good if it does not materially affect your trading strategy's profitability.

Why are spreads wider during market open?

Spreads are wider at market open because liquidity is lower and uncertainty is higher. Overnight news, pre-market trading activity, and the auction process create price discovery at the open. Market makers widen spreads to compensate for the increased risk of adverse price moves. Spreads typically tighten within 15-30 minutes as the market establishes an equilibrium price and volume picks up. The first 15 minutes of trading often have the widest intraday spreads across all asset classes.

How do brokers make money on spread?

Brokers using the market maker or dealing desk model earn revenue directly from the spread they quote to clients. Instead of charging a commission, they widen the spread and keep the difference. In the forex market, many brokers operate as market makers, offering fixed or variable spreads that include their profit margin. ECN brokers, by contrast, pass the raw interbank spread to clients and charge a small commission per trade. The total cost (spread + commission) is typically lower on ECN accounts for active traders, while casual traders may prefer the simplicity of dealing desk pricing.

Does spread cost matter for long-term investors?

Spread costs are minimal for long-term buy-and-hold investors who trade infrequently. A 0.05% spread cost on a position held for 5 years is negligible. However, if you contribute to your portfolio monthly (dollar-cost averaging), spread costs can add up over decades. A $10,000 monthly investment with a 0.05% spread costs $5/month or $60/year. Over 30 years at 7% returns, that is approximately $5,500 in lost compound growth. It is still small relative to portfolio size, but worth optimizing by using limit orders and trading liquid ETFs. Dollar-cost averaging and trading cost optimization →

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