An investor buying, selling or trading any type of security will be confronted with bid and ask prices. The bid price is how much you can sell the security for, while the ask price is where you can buy. Bid and ask prices are used with stocks, stock options, futures, bonds and foreign currency, or forex. Spreads are trading costs and an investment must first overcome the spread amount and percentage before a trade or new investment moves into profitable territory. Calculate a stock market spread as an example of direct cost investing and a forex spread as an example using a large amount of leverage.
Stock Market Spreads
Write down the bid and ask spread of a stock in which you are considering to invest. An online brokerage account quote or trade screen will show both the bid and ask prices. As an example, consider stock XYZ with a bid price of $40.55 and an ask price of $40.65 per share.
Subtract the bid price from the ask price to calculate the spread per share. In the example, the spread is 10 cents.
Multiply the spread per share times the number of shares you plan to buy to calculate the spread cost. Using the example spread and an investment of 500 shares, the spread cost to buy the 500 shares would be $50.
Divide the spread per share by the ask price, then multiply times 100 to calculate the spread percentage. For the example stock, 10 cents divided by $40.65 times 100 gives a spread of 0.25 percent.
Write down the current bid and ask prices for a forex currency pair. For example, use the Euro-U.S. dollar bid price of $1.42760 and an ask price of $1.42786. Currency pairs are quoted as the cost of the first listed currency in the second currency.
Subtract the bid price from the ask price. For most currency pairs, the difference will be out at the fourth and fifth decimal place. For the example EUR/USD quote, the difference is $0.00026. Forex trading uses the term "pip" for the smallest value step, which is the fourth decimal point for most currency quotes. This example spread amount is 2.6 pips.
Multiply the quote spread in decimal form times the size of the projected currency trade. The standard lot size for currency trading is $100,000 and a mini-lot is $10,000. For the example, bid-ask spread of $0.00026, the cost of the spread for a standard currency lot is $26.
Divide the spread cost by the required margin amount, then multiply by 100 to calculate the spread percentage for the currency trade. Currency trading rules allow leverage of up to 50:1. At this level, a $100,000 currency lot can be traded with a margin deposit of $2,000. For the example, dividing the spread cost of $26 by the margin deposit of $2,000 multiplying times 100 produces a spread percentage of 1.3 percent.
The traditional forex pip is at 4 decimal places. Many brokers now quote rates to five places, resulting in fractional pip spreads. The stock spread example can be expanded to calculate the spread for any direct cost investment. Use the forex example as a guide for calculating spread percentage for investments with a high degree of leverage. Stock spreads will be as low as 1 cent for actively traded stocks. Thinly traded stocks can see spreads of 10 cents or more.
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