Learn what bid prices mean and what they do in CFD trading

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An Introduction To CFDs

The contract for difference (CFD) offers European traders and investors an opportunity to profit from price movement without owning the underlying asset. It’s a relatively simple security calculated by the asset’s movement between trade entry and exit, computing only the price change without consideration of the asset’s underlying value.   This is accomplished through a contract between client and broker, and does not utilize any stock, forex, commodity or futures exchange. Trading CFDs offer several major advantages that have increased the instruments’ enormous popularity in the past decade.

How a CFD Works

If a stock has an ask price of $25.26 and the trader buys 100 shares, the cost of the transaction is $2,526 plus commission and fees. This trade requires at least $1,263 in free cash at a traditional broker in a 50% margin account, while a CFD broker formerly required just a 5% margin, or $126.30. A CFD trade will show a loss equal to the size of the spread at the time of the transaction so, if the spread is 5 cents, the stock needs to gain 5 cents for the position to hit the breakeven price. You’ll see a 5-cent gain if you owned the stock outright but would have paid a commission and incurred a larger capital outlay.

If the stock rallies to a bid price of $25.76 in a traditional broker account, it can be sold for a $50 gain or $50/$1263 = 3.95% profit. However, when the national exchange reaches this price, the CFD bid price may only be $25.74. The CFD profit will be lower because the trader must exit at the bid price and the spread is larger than on the regular market. In this example, the CFD trader earns an estimated $48 or $48/$126.30 = 38% return on investment. The CFD broker may also require the trader to buy at a higher initial price, $25.28 for example. Even so, the $46 to $48 earned on the CFD trade denotes a net profit, while the $50 profit from owning the stock outright doesn’t include commissions or other fees, putting more money in the CFD trader’s pocket.

What is spread in forex?

In forex trading, the spread is the difference between the bid (sell) price and the ask (buy) price of a currency pair.

There are always two prices given in a currency pair, the bid and the ask price. The bid price is the price at which you can sell the base currency, whereas the ask price is the price you would use to buy the base currency.

The base currency is shown on the left of the currency pair, and the variable, quote or counter currency, on the right. The pairing tells you how much of the variable currency equals one unit of the base currency.

The buy price quoted will always be higher than the sell price quoted, with the underlying market price being somewhere in-between.

Most forex currency pairs are traded without commission, but the spread is one cost that applies to any trade that you place. Rather than charging a commission, all leveraged trading providers will incorporate a spread into the cost of placing a trade, as they factor in a higher ask price relative to the bid price. The size of the spread can be influenced by different factors, such as which currency pair you are trading and how volatile it is, the size of your trade and which provider you are using.

Some of the major forex pairs include:

  • EUR/USD
  • USD/JPY
  • GBP/USD
  • USD/CHF

What does spread mean?

The spread is measured in pips, which is a small unit of movement in the price of a currency pair, and the last decimal point on the price quote (equal to 0.0001). This is true for the majority of currency pairs, aside from the Japanese yen where the pip is the second decimal point (0.01).

When there is a wider spread, it means there is a greater difference between the two prices, so there is usually low liquidity and high volatility. A lower spread on the other hand indicates low volatility and high liquidity. Thus, there will be a smaller spread cost incurred when trading a currency pair with a tighter spread.

When trading, the spread can either be variable or fixed. Indices, for example, have fixed spreads. The spread for forex pairs is variable, so when the bid and ask prices of the currency pair change, the spread changes too.

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Some of the benefits and drawbacks of these two types of spreads are outlined below:

Fixed Spread Variable Spread
Could face requotes No risk of requotes
Predictable transaction costs Can get a tighter spread than fixed
Smaller capital requirements Can reveal market liquidity
More appropriate for novice traders More appropriate for experienced traders
A volatile market won’t effect the spread Spread can widen rapidly if there is high volatility
Likely to be exposed to slippage Can be exposed to slippage

Spread calculator

The spread is calculated using the last large numbers of the buy and sell price, within a price quote. The last large number in the image below is a 3 and a 4. When trading forex, or any other asset via a CFD or spread betting account, you pay the entire spread upfront. This compares to the commission paid when trading share CFDs, which is paid both when entering or exiting a trade. The tighter the spread, the better value you get as a trader.

For example:

The bid price is 1.26739 and the ask price is 1.26749 for the GBP/USD currency pair.

If you subtract 1.26739 from 1.26749, that equals 0.0001.

As the spread is based on the last large number in the price quote, it equates to a spread of 1.0.

​Forex spread indicators

The spread indicator is typically displayed as a curve on a graph to show the direction of the spread as it relates to bid and ask price. This helps visualise the spread in the forex pair over time, with the most liquid pairs having tighter spreads and the more exotic pairs having wider spreads.

Factors which can influence the forex spread include market volatility, which can cause fluctuation. Major economic news, for example, can cause a currency pair to strengthen or weaken – thus affecting the spread. If the market is volatile, currency pairs can incur gapping, or the currency pair becomes less liquid, so the spread will widen.

Keeping an eye on an economic calendar can help prepare you for the possibility of wider spreads. By staying informed as to what events might cause currency pairs to become less liquid, you can make an educated prediction as to whether their volatility might increase, and thus whether you might see a greater spread. However, breaking news or unexpected economic data can be difficult to prepare for.

There will also be a lower spread for currency pairs traded in high volumes, such as the major pairs containing the USD. These pairs have higher liquidity but can still be at risk of widening spreads if there is economic volatility.

During the major market trading sessions, like London, New York and Sydney sessions, there are likely to be lower spreads. In particular, when there is an overlap, such as when the London session is ending and the New York session is beginning, the spread can be narrower still. The spread is also influenced by the general supply and demand of currencies – if there is a high demand for the euro, the value will increase.

Spread and margin

If the forex spread widens dramatically, you run the risk of receiving a margin call, and worst case, being liquidated. A margin call notification occurs when your account value drops below 100% of your margin level, signalling you’re at risk of no longer covering the trading requirement. If you reach 50% below the margin level, all your positions may be liquidated.

It’s therefore important to gauge how much leverage you’re trading with and the size of your position. Forex pairs are usually traded in larger amounts than shares, so it’s important to remain aware of your account balance.

Summary

A forex spread is the difference between the bid price and the ask price of a currency pair, and is usually measured in pips. Knowing what factors cause the spread to widen is crucial when trading forex. Major currency pairs are traded in high volumes so have a smaller spread, whereas exotic pairs will have a wider spread. See our guide on risk management when trading.

We offer competitive spreads on a range of currency pairs, including major pairs such as EUR/USD and GBP/USD.

Disclaimer

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

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What is a contract for difference?

A contract for difference (CFD) is a popular form of derivative trading. CFD trading enables you to speculate on the rising or falling prices of fast-moving global financial markets (or instruments) such as shares, indices, commodities, currencies and treasuries.

Among the benefits of CFD trading are that you can trade on margin, and you can go short (sell) if you think prices will go down or go long (buy) if you think prices will rise. You can also use CFDs to hedge an existing physical portfolio.

How do CFDs work?

When you trade CFDs, you don’t buy or sell the underlying asset (e.g. a physical share, currency pair or commodity). We offer CFDs on thousands of global markets and you can buy or sell a number of units for a particular product or instrument depending on whether you think prices will go up or down. Our wide range of products includes shares, treasuries, currency pairs, commodities and stock indices, such as the Singapore Free.

For every point the price of the instrument moves in your favour, you gain multiples of the number of units you have bought or sold. For every point the price moves against you, you will make a loss. Please remember that losses can exceed your deposits.

What is margin and leverage?

CFDs are a leveraged product, which means that you only need to deposit a small percentage of the full value of the trade in order to open a position. This is called ‘trading on margin’ (or margin requirement). While trading on margin allows you to magnify your returns, your losses will also be magnified as they are based on the full value of the position, meaning you could lose more than any capital deposited

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What are the costs of CFD trading?

Spread: As in all markets, when trading CFDs you must pay the spread, which is the difference between the buy and sell price. You enter a buy trade using the buy price quoted and exit using the sell price. As one of the leading CFD providers globally, we understand that the narrower the spread, the less you need the price to move in your favour before you start making a profit or loss. Our spreads are therefore always competitive so you can maximise your ability to net a potential profit.

Holding costs: At the end of each trading day (5pm New York time), any positions open in your account may be subject to a charge called a ‘holding cost’. The holding cost can be positive or negative depending on the direction of your position and the applicable holding rate.

Market data fees: To trade or view our price data for share CFDs you must activate the relevant market data subscription for which a fee will be charged. View our CFD market data fees.

Commissions (only applicable for shares): You must also pay a separate commission charge when you trade share CFDs. Commissions on AUS-based shares on the CMC Markets CFD trading platform start from 0.09% of the full exposure of the position, and there is a minimum commission charge of $7.

Example 1 – Opening Trade

A 12,000 unit trade on AUS Company ABC at a price of $1.00 ot 100 cents would incur a commission charge of $10.80 to enter the trade:​

12,000 (units) x 100 cents (entry price) = $12,000 x 0.09% = $10.80

Example 2 – Opening Trade

A 5,000 unit trade on AUS Company ABC at a price of $1 or 100 cents would incur the minimum commission charge of $7 to enter the trade:
5,000 (units) x 100 cents (entry price) = $5,000 x 0.09% = $4.50As this is less than the minimum commission charge for AUS share CFDs, the minimum commission charge of $7 would be applied to this trade.)

Please note: CFD trades incur a commission charge when the trade is opened as well as when it is closed. The above calculation can be applied for a closing trade, the only difference is that you use the exit price rather than the entry price.

Example of a CFD trade

Buying a company share in a rising market (going long)

In this example, AUS Company ABC is trading at $9.98 / $10.00 (where $9.98 is the sell price and $10.00 is the buy price). The spread is 2.

You think the company’s price is going to go up so you decide to buy 1,000 CFDs, or ‘units’ at $10.00. A separate commission charge of $9 would be applied when you open the trade, as 0.09% of the trade size is $9 (1,000 units x $10.00 = $10,000 x 0.09%).

Company ABC has a margin rate of 3%, which means you only have to deposit 3% of the total value of the trade as position margin. Therefore, in this example your position margin will be $300 (1,000 units x $10.00 = $10,000 x 3%)

Remember that if the price moves against you, it is possible to lose more than your margin of $300, as losses will be based on the full value of the position.

Outcome A: a profitable trade

Your prediction was correct and the price rises over the next week to $11.00 / $11.02. You decide to close your buy trade by selling at $11.00 (the current sell price). Remember, commission is charged when you exit a trade too, so a charge of $9.90 would be applied when you close the trade, as 0.09% of the trade size is $9.90 (1,000 units x $11.00 = $11,000 x 0.09%).

The price has moved $1.00 in your favour, from $10.00 cents (the initial buy price) to $11.00 cents (the current sell price). Multiply this by the number of units you bought (10,000) to calculate your profit of $1,000, then subtract the total commission charge ($9 at entry + $9.90 at exit = $18.90) which results in a total profit of $981.10

Outcome B: a losing trade

Unfortunately, your prediction was wrong and the price of Company ABC drops over the next week to $9.30 / $9.32. You think the price is likely to continue dropping so, to limit your losses, you decide to sell at $9.30 (the current price) to close the trade. As commission is charged when you exit a trade too, a charge of $8.37 would apply, as 0.09% of the trade size is $8.37 (1,000 units x $9.30cents = $9,300 x 0.09%).

The price has moved 70 cents against you, from $10.00 (the initial buy price) to $9.30 (the current sell price). Multiply this by the number of units you bought (1,000) to calculate your loss of $700, plus the total commission charge ($9 at entry + $8.37 at exit = $17.37) which results in a total loss of $717.37.

Short-selling in a falling market

If you decide to sell a product that you believe will fall in value and your prediction turns out to be correct, you can buy the product back at a lower price at a profit. If you are incorrect and the value rises, you will make a loss. This loss can exceed your deposits.

Hedging your physical portfolio

If you have already invested in an existing portfolio of physical shares with another broker and you think they may lose some of their value over the short term, you can hedge your physical shares using CFDs. By short selling the same shares in CFDs, you can try and make a profit from the short-term downtrend to offset any loss from your existing portfolio.

For example, say you hold $5,000 worth of physical ABC Corp shares in your portfolio; you could short sell the equivalent value of ABC Corp with CFDs. Then, if ABC Corp’s share prices fall in the underlying market, the loss in value of your physical share portfolio could potentially be offset by the profit made on your short sell CFD trade. You could then close out of your CFD trade to secure your profits as the short-term downtrend comes to an end and the value of your physical shares starts to rise again.

Using CFDs to hedge physical share portfolios is a popular strategy for many investors, especially in volatile markets.

Attend one of our regular CFD trading webinars or seminars and improve your CFD trading skills.

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

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