In the financial world, buy and sell prices usually differ from each other. In spread trading, we take advantage of these often minimal differences! We explain how the various forms of spread trading work and how to use them successfully. 

What is spread trading?

In our economic system, prices are determined by supply and demand. This is no different on the financial markets! For example, it could happen that a share costs € 101 on the stock exchange. But if you buy the security in your Equity portfolio and want to sell, you will only receive €100 at the same time. 

In spread trading, we make targeted use of such differences:

• The spread is the difference between the price demanded (“ask price”) and the price offered (“bid price”) 
• Deviations between the two values are the rule and we encounter them on the stock exchange, in interest rates, in trading and in many other places
• This price difference is variable and can change at any time
• We can use the existing differences or the changes in spreads to generate profits

Spread trading is simply a generic term for all types of transactions in which we take advantage of price differences. We can use it in different markets and with different strategies. 

Spread trading examples: The most important forms explained

Spreads are found in almost all financial markets because they represent the most fundamental concept of our entire economy: the intention to make a profit. 

Market participants always want to buy cheaply and sell expensively. The spread reflects precisely this intention: depending on whether you want to buy or sell an asset, you have to pay a higher or lower price. 

Depending on the market, the exact framework conditions, amount, pricing, etc. may vary slightly. A distinction is therefore made between several types: 

Course-related

No matter whether you Future Trading and Day trading with shares or simply to the classic Value Aktien set: With every transaction on the stock exchange, you encounter the spread, i.e. the Price difference between purchase price and sales price. 

• If the trading volume is high, the spread usually falls as well
• Traders can use different spreads to make small profits 
• You trade long and short positions on the same asset (e.g. a future with the same underlying asset), but with other deviations
• The differences can be, for example, the term, the trading venue or the strike price of the derivative

Different trading venues also have different liquidity: Most shares have a lower spread on their “home exchanges” and are therefore available more cheaply. This is because securities are very frequently traded over the digital counter on these exchanges! 

Conversely, they often have to pay higher premiums for such securities on exotic trading venues and small exchanges. There is simply a lack of the necessary trading volume and the spreads increase accordingly. 

Traders can take advantage of these differences and buy on one trading venue and sell on another. Variations in the strike price or the term are also possible. 

In this form of spread trading, we hold a long and a short position on the same asset so that profits and losses are largely balanced. The risk is therefore limited; at the same time, our potential profits are also limited to the spread. 

Date-related

In this form of spread trading, traders use two positions on the same asset, but with different maturities. Depending on the combination, they can profit from rising or falling prices. As both a long and a short position are held, the risk of price losses is limited. 

Foreign exchange trading

At Foreign exchange trading, We also encounter spreads when trading with foreign currencies. For trading with means of payment Futures or Forward exchange transactions are used. These transactions involve betting on the future exchange rate of a currency. 

A distinction is made here: 

1. The Current price of a currency (“spot price”)
2. The Future price, agreed in a forward contract (“forward price” or “forward rate”)

The difference between these two values is also called Spread and is actively used in foreign exchange trading to generate profits. 

Interest rate spreads

There are also differences in interest rates, i.e. the average interest rate, is referred to as a spread. When trading interest rate products such as short-term bonds these price differences can play a role, as they influence the attractiveness of some products (and consequently demand and price). 

This could look like this in practice: 

• A private individual took out a loan some time ago and is currently paying it off with interest of 5.5 %. 
• Since then, prime rates have fallen sharply and another bank is now offering a loan with 3.5 % interest. 
• The borrower accepts this offer and reschedules his loan. 
• He has made a profit of 2 % from the interest spread (= difference in interest rates). 

Debt restructuring of this kind is commonplace in the financial world. But it doesn't just have to be loans: Spread trading, or an interest rate spread, also exists when you withdraw your assets in order to obtain higher interest rates elsewhere. 

Inter-asset spreads and inter-market spreads

In this form of spread trading, we use the difference (spread) between two different but related assets. We speculate that the distance between the two values will change. 

Examples:

• Donald Trump's tariff dispute with China and the rest of the world continues. Due to the strain on the US economy, you could buy the Shanghai Composite Index and at the same time buy a Short sale on the Russell 2000. With this form of spread trading, you would be speculating that the Chinese economy would weather the trade war better than its US counterpart. 
• Technology companies are currently outperforming other sectors. They could specifically AI shares or the NASDAQ index and at the same time sell an ETF that excludes technology stocks (for example the SPXT, a variation of the S&P 500 without technology stocks). With this spread trade, you would be betting on a further outperformance of technology companies. 
• Do you expect interest rates on short-term German government bonds to rise but the key interest rate to fall? You could create a spread trade (“intermarket spread”): a long position on German government bonds, for example via the Euro-Bund future, combined with a short position on the EURIBOR (EU reference rate). In this constellation, you benefit from a rising difference between the two interest rates. 

The possibilities of such inter-asset or inter-market spreads are almost unlimited. Because “related assets” is a very elastic term! In addition to the relatedness of the traded assets, maturities, spreads and more can also be adjusted, which provides further strategic depth. 

Is spread trading illegal? What you should know!

If you use two opposing positions for a trade, there are a few rules to follow. Because not all forms of spread trading are legal! 

• It is market participants prohibited from concluding share transactions with themselves that cancel each other out. 
• This so-called “wash trading” is used to artificially inflate the demand for securities and simulate a high trading volume. 
• However, simultaneous buying and selling on different trading venues is permitted, which theoretically offers further opportunities for spread trading. 
• Agreed transactions with other persons (e.g. for tax reasons) are also prohibited. 

The concept of “direct executability” is crucial here: If orders from a single person for a security are matched and can be executed directly, the transaction violates the EU Market Abuse Regulation and the conditions for transactions on the Frankfurt Stock Exchange. 

Simultaneous trading with opposing positions is also complex and strictly regulated for brokers. For example, there are important requirements to avoid “cross-trading”, a method whereby a broker processes opposing orders from its customers internally and does not report them to the exchange. 

Spread trading is therefore by no means illegal; However, some forms are subject to regulations designed to prevent market manipulation. Your broker may therefore reject some trades.

Spread trading in practice

In everyday life, the term spread trading almost always refers to a financial transaction in which a trader both long and short positions takes. Profits are generated by changes in the price difference. 

As they have both “legs” of the trade, price changes almost completely cancel each other out. This can drastically reduce the risks, as in the worst-case scenario only comparatively small losses may occur or the hoped-for profit may not materialize. A loss of the capital invested in the two positions, on the other hand, is rather unlikely. 

There are several ways to profit from spread trading. Attractive profits can be made, especially if the difference between the buying and selling price fluctuates significantly. The following use cases have become established: 

Spread trading example: Foreign exchange

Foreign exchange is an obvious field for trading price differences and there are several variants available. Particularly popular: the Combination of a spot transaction with an opposite forward transaction. Such a "Swap transaction" offers retailers the opportunity to profit from price changes. 

Traders can bet on rising or falling prices: 

• If you expect a bullish price trend for a currency, you buy it immediately. At the same time, you sell the same means of payment in the future, for example via a Forward exchange transactionfor a higher price. 
• If prices rise as expected, the spread between the two transactions decreases: You have made a profit! If, on the other hand, you were wrong with your forecast, your loss is limited, as the two positions largely balance each other out. 
• If you expect the price to fall, you simply have to sell at a lower price in the future. 
• If you have correctly assessed the market, you will also profit. Otherwise, you will again incur a small loss.

Spread trading example: Futures

Trading price differences is hugely popular with futures. So popular that you don't have to do it manually, you can simply trade “future spreads”! 

Not only are these deals easier to manage (you don't have to open, monitor and close two positions yourself), but they also require less capital: your broker recognizes the lower risk because you hold both a short and long position. 

Any losses and gains largely balance each other out. A Margin Call is less likely and your margin requirement decreases. 

There are two main variants for future spreads: 

Inter-commodity futures spreads

With inter-commodity futures, we trade different but similar commodities. 

• This spread trade uses different underlying assets but the same term
• The difference (spread) can increase or decrease and thus generate a profit 
• The two commodities must be related and correlated for this approach to be successful. 
• You do not have to find out for yourself which underlying assets are related. Your broker will provide you with a selection of typical values. 

For example, if a trader expects the price of the underlying asset copper to rise, he opens a long position. At the same time, he takes a short position on the underlying asset gold, which is closely linked to copper. 

If he was correct with his forecast and the price of copper rises while gold falls or remains the same, the difference is reduced and forms the potential profit. Here, too, the risk is limited, as two positions move against each other. 

Other typical commodity pairs include US oil (WTI) and “North Sea oil” (Brent) or wheat and corn. 

• Possible dangers: Since a commodity does not necessarily have to follow the movements of a correlating asset, losses can still occur. In general, however, the risk (and therefore the margin requirement of your broker!) is lower. 

Intra-Commodity Calendar Spreads

This form also uses commodity futures and a long and short position together. However, this is done using only a single underlying and trades it with a time lag. 

Here, too, you can speculate on rising or falling prices: 

• Spread trading with rising prices: You purchase futures in a long position for the near future (short term). At the same time, you open futures in a short position with a higher price and a longer term. 

If the price of the commodity rises, the gap between the two positions decreases. You can book the difference as a profit. 

• Spread trading with falling prices: You open a short position for a future with a short term. At the same time, you acquire another future in a long position with a longer term and a lower price. 

If the price of the commodity falls, the price difference between the two trades decreases. The difference forms your profit. 

Intra-commodity calendar spreads therefore work very similarly to differential trading in foreign exchange. An options broker offers you the opportunity to execute such trades directly without having to open the two positions manually. 

Spread trading example: interest rate spreads

Trading in interest-bearing products is considered the simplest form of spread trading. The Spread is the difference between two interest rates for similar or identical financial products. 

Example: 

• You have been using a call money account for a long time and receive 1.0 percent interest. 
• Thanks to slight increases in interest rates, offers of up to 1.8 % interest per year are now available. 
• You switch to a new call deposit account with an interest rate of 1.8 %. 
• By switching, you have taken advantage of an interest rate spread and achieved an additional annual return of 0.8 % 

This type of trading is less significant for private investors (it occurs rather rarely), but plays an important role for banks, hedge funds and other institutions: even the smallest differences in interest rates can generate handsome profits there, as huge sums are moved. 

Conclusion: Spread trading for trading with less risk

With spread trading, you trade with the differences between the buy and sell price. For most variants, you have to correctly predict the development of these prices. 

The practical execution takes place by adopting two opposing positions: 

• If you go long and short on the same underlying asset, but with different maturities, you benefit from changes in the price difference. 
• It is also possible to trade related assets at the same time with opposing positions. In this case, you can also make profits by changing the spread, provided you forecast the development correctly. 

If prices change, your capital remains largely the same: you lose money on one position but gain it on the other. This form of trading is therefore considered less risky. Although smaller losses are possible and your planned return can disappear into nothing, the capital invested remains safe. 

This reduced risk is also reflected in the prices: your broker can offer spread trading much more cheaply and with higher margins! This makes spread trading a popular form of trading for people with small accounts. It can also be combined very well with the Trade options combine.