Spread trading is where CFD providers have a wider spread on the share price or underlying asset.
Providers who don’t charge commission will use a wider spread to generate income and the benefit is that you don’t have to pay commission.
So how does spread trading work?
For example, if the current value of Rio Tinto is $66.00, then the following is true:
RIO TINTO Share Price (Underlying Asset)
Sell Price Last Price Buy Price
65.99 66 66.01
The Rio Tinto CFD Spread will then have the following prices:
RIO TINTO CFD Spread
66.03 32 cents more than the last share price)
Sell & CFD Provider Last Price
65.97 (3 cents less than the last share price)
Trader buys when market last price is 66.00
CFD Provider buys at 66.03
Trader’s stop loss is 10 points: 65.93
Trader’s Limit Order (target selling price) is 7 points: 66.10
If a trader places an order when the last price is 66.00, the CFD Provider buys Rio Tinto at $66.03. The trader will immediately be negative due to the CFD spread. That is, the trader has bought at a price higher than the market value and can only sell at lower the market value. This puts you 4 points away from your stop loss, and 13 points away from your limit order.
If you want to sell, the provider will sell at 3 points below the market price. At a market price of 66.00, the Provider will sell for you at 65.97.
In this circumstance the trader is fighting against the odds and is not helping the situation by placing the stop loss to close to the provider’s last price of $65.97.
Therefore when using CFD Providers who utilize spread trading, set your stop loss at a comfortable distance so that you are not taken out of your position too soon. Similarly, this situation will apply if the trader sells first (or goes short).