With the emergence and increasing popularity of financial spread betting, the importance of education and awareness for individual participants is paramount. The appeal is clear: low-cost of entry, and the real potential for profit. However, the risk of loss is equally real, so like most financial undertakings users should first understand the basics before cautiously proceeding.
Financial Spreads exist in most markets. Essentially, the difference between the bid and ask price asset, like a stock, is the spread. Similarly, financial spreads exists in markets for commodities, options, currencies, and more. Bonds, for example, that offer different yields can be measured by their spread.
The size of the financial spread can vary significantly, theoretically from nil or zero spread to a complete loss. A transaction without any spread is said to be a frictionless trade. In reality, market forces dictate the scope of the margin as both buyer and seller must agree that the financial spread is acceptable before the transaction is carried out.
Liquidity is a critical concept in determining the size of financial spreads. Some argue that the financial spread is a reflection of the demand for liquidity in financial transactions. With liquidity being the speed at which a seller can convert their investments to cash without loss of capital. To put this another way, the financial spread is the cost of making transactions without delay.
To illustrate the importance of liquidity in determining the relative size of a financial spread I like to use more tangible real-life examples, like cars. Assume that you wanted to upgrade your current car. Under normal circumstances you will have a clear choice as to the best way to sell off your car. Firstly, you could simply trade-in your ride to the car dealership and accept the best offer they will give you. This is the fastest way to get out of your car and into your new one, but it comes at a price. The dealership will offer you the lowest market price as they are skilled at exploiting your desire for a speedy exchange. A speedy stress-free transaction results in a wide financial spread that you are paying for.
Alternatively, you could sell your vehicle privately. This will take some time, however your patience will likely be rewarded with a better price and thus minimize your financial spread.
Whichever financial market you choose to engage in, take the time to study its intricacies and peculiarities to give yourself the best chance at making informed decisions.