SYou have surely seen the term spread at some point, exchange or cryptocurrency platform, and you may have wondered What does spread mean? Well, a spread, generally refers to the difference between the purchase price (bid) and sale (ask) for a certain security within that exchange or platform.
If you have participated in an exchange or stock market, you will have seen that normally the purchase and sale prices of assets in the markets have slight or marked differences. You can see this more clearly in the exchange's order book. The difference between the purchase offer at the highest price and the lowest sale price offer is known as the spread.
This difference between the highest price at which one person is willing to buy, and the lowest price at which another person is willing to sell, would reflect the disagreement between the two prices. However, spreads have other functions beyond simply marking price differences, in fact, they can be a powerful tool to analyze markets and allow to study their evolution.
How does a spread really work?
In an exchange, the most common is to see three prices:
- The lowest price someone wants to sell at.
- Highest price someone wants to buy at.
- The price of the last exchange.
The difference between point 1 and point 2 is the spread. Although the last exchange was made at a price, it does not mean that if you buy or sell you will do it at the same price.
A large difference between the purchase price and the sale price is usually related to exchange houses with little liquidity. Remember that in cryptocurrencies Each exchange has its own market. And in one house it can be very liquid and in another not, something that is usually used to arbitrage.
Furthermore, a spread always reflects a difference in perception of the value. Along with this are speculators who always seek to obtain benefits, and the sooner the better, that is why they seek to move one price away from the other.
Of course, this buying and selling action in an exchange is carried out between multiple people and the force of all of them is what moves prices up or down at different times. This is what makes possible what we call average market prices, which are the market prices of an asset, and which allow you, for example, to make quick operations at “market price”.
Factors that determine a spread
A very common mistake in people who enter the world of trading or buying and selling cryptocurrencies on different platforms, is to think that the spread is a variable imposed by the platform. The reality is that the spread values depend on the asset being traded and how the market reacts to that asset, along with its supply and demand.
In that case, some of the factors that determine a spread are:
- High levels of asset trading. For example, a cryptocurrency with high trading activity will have a fairly small spread, while one with low activity will have a larger spread.
- The market is very liquid. Which also has a great impact on spread levels. The higher the liquidity, the spreads tend to be lower, and the opposite happens when there is less liquidity.
- Many traders manage the asset. A situation that also impacts spread levels.
- The volatility of the asset. At this point, volatility can lead to more or less high spreads depending on the trend of the global price of the asset.