Definition of Financial Spreads
The simple definition of "Spread" in the financial world is the difference of bid and ask price. In other words financial spreads are nothing but the difference in Price and Cost.
Spread = Difference in Price and Cost
Spread = Price we would get - Cost ( a simple Price - Cost Formula)
Bid price is the price which the trader in front of you asks for if you want to sell something. The "buyer" quotes the bid price to but that "something" from you.
Ask price is the price which the trader in front of you quotes when you want to buy something. The "seller" quotes the ask price to sell that "something" from you.
Trading and Spreads
In financial world, whether it is Forex, securities, stocks or any commodity, the traders trade on both side. They buy the same thing when they speculate that the prices will go up and they sell that same thing when they speculate that the prices would go down.
Is the above statement true? If we go a bit deeper, we would find that though the statement is true but not practical. Even the best of the traders or trading entities in the financial market cannot guarantee if the price of the security is going to go up or down. Trading is all about speculation but a calculated speculation by analyzing different market forces.
Considering the above, there will always be buyers and sellers for the same thing. Many of the buyers or sellers will be the real buyers or sellers because of the need and many more just for the speculative trading. Now there will be large financial entities to serve the needs of both these buyers and sellers. They provide the liquidity to the market and they are called the market makers. They offer to buy the same thing from a seller and offer to sell that same thing to another buyer at the same time.
For trading terminology the spread is nothing but the difference between the bid and the ask price. If we see the definitions of Bid and Ask price and the formula of spread as mentioned above, it would change the terms and hence the formula as follows:
Bid price = Price we would get
Ask Price = Price we would pay i.e. cost
so Spread = Bid price - Ask price.
Then How Do They (brokers) Earn Their Daily Bread?
Well, they earn their money by the difference in the buying and selling prices which they quote. And this difference is called "Spread". They buy at low price and they sell at a higher price than the price they buy and that difference is their profits.