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TRADING BASICS
Courtesy of
DailyFX.com
The difference between the price you at buy at (also known as the ask)
and the price you sell at (also known as the bid).
In all traded instruments - stocks, bonds, futures, commodities, foreign
exchange, etc. - there is what is known as a spread. The spread is the required
cost of the trade; it is the cost imposed by the party that actually executes
your trade. The more directly you interact with the party that executes your
trade, the lower your cost will be.
Unlike more commonly recognized financial service charges, like commissions,
the spread is not a fixed dollar cost market participants pay. Instead, a
spread requires the creation of two prices by the firm you are trading with:
the price you buy at, and the price you sell at. The firm that executes your
trade will buy at one price, and sell to you at another price. Thus, if you
wanted to buy a position and sell right away, you would have to sell at a
lower price, since you have to sell at the sell price (which is lower than
the buy price). This essentially creates a scenario in which the price of
the product you are speculating on must rise by a certain amount before you
can close your position, as the sell price must rise enough so that it is
equal to the buy price that you bought at if you wish to at least break even.
Thus if a buyer bought at 50 and wanted to sell right away, he/she would
have to sell at 45. In this example, the rate needs to move up 5 pips - meaning
the quote would be 55-50 -- before the buyer can break even by selling at
the sell rate of 50. Clearly, the spread is the cost of the trade: the rate
moved 5 pips, but the client's net P/L at that point was still zero.
Transparent Spread: Knowing the True Cost of the Trade
The ability to sell the buy price (ask) and the sell price (bid) at all times.
Historically speaking, most individual traders have not been able to "see"
the spread when they are trading. Instead, they are given only one quote:
the price they can buy at, or, if they are selling, the price they can sell
at. As a result, the spread has historically been a "hidden" cost, concealed
by the firm that executes your trade. Conveniently, this allows the executing
firm to widen the spread when necessary, thus effectively increasing the cost
of the trade without really notifying the majority of market participants.
With the proliferation of democratizing technology such as the Internet,
though, the market has become more transparent: finally, the individual trader
can see the spread, and thus will know exactly what the cost of the trade
is prior to entering a position.
Next: Leverage:
Trading With Borrowed Funds
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