Why Zero Spread Zero Fee Trading Is Misleading
An overview of spreads, fees, CFDs, and the risks in creating artificially cheap trading conditions.
5 minutes read
8. 1. 2024
An overview of spreads, fees, CFDs, and the risks in creating artificially cheap trading conditions.
Prop firms compete on many parameters.
Among these parameters are spreads and fees.
Intuitively, one is inclined to believe that lower fees and lower spreads are better. These are costs that traders must pay when they trade, and a lower cost of trading increases the likelihood of profitability.
Intuitive as it may be, it is not always true. In fact, ultra low spreads and fees can be misleading.
Let’s first define the terms.
A spread is the difference between the bid and the offer in an instrument. If the difference is small, the market is tight or narrow. If the difference is large, then the market is wide.
Spreads are generally dynamic. Market participants, especially market makers and other liquidity providers, choose how tightly or widely to quote a market.
For example, for a popular, high volume trading instrument where market making is competitive, spreads will generally be quite narrow. Conversely, for more exotic or newer trading pairs, spreads will generally be wider.
Even in tightly quoted markets, spreads can widen based on news events, vary from session to session, and so on.
In some cases, the spread alone does not give a complete picture. For example, it’s possible for a spread to be tight (i.e. the difference between the nearest bid and offer to be small) but for the market depth (or available liquidity) around the best bid or offer to be quite low. In these instances, the spread looks narrow but crossing it results in significantly worse fill prices.
Fees refer to commissions, or generally, the cost of opening and closing positions in an instrument.
The cost of trading consideration is generally more straightforward: higher costs eat into profitability, and lower costs are preferable as a result.
It is important to note that spreads and fees are by no means mutually exclusive costs. In fact, in most cases, they work synergistically.
For example, it’s common for a very low or 0 spread instrument to make up for the cost via wider spreads. The reverse is also common i.e. wider spreads but low or 0 fees, depending on the market that is being quoted.
There is no free lunch. The broker or liquidity provider must make money somewhere. Spreads, fees, or some combination of both are the most appropriate avenues for revenue.
Ultra low fees and spreads are typically offered via CFDs (contracts for difference).
For crypto trading specifically, the industry standard has been CFDs with low fees but wide spreads (often provided by a traditional FX brokerage, not a crypto-centric entity). More recently, there has been an influx of near 0 spread CFDs with very low fees for crypto trading.
CFDs are generally very intuitive products that allow traders to gain leveraged long/short exposure to an instrument without having to own the underlying instrument itself. For example, traders can speculate on the price of Bitcoin via a Bitcoin CFD without needing to own or borrow any physical Bitcoin.
One downside of CFDs is opaqueness.
To be specific: unlike a futures contract or spot market where the quotes and liquidity are visible via a central limit order book, the source of liquidity for a CFD product is not visible as it is traded over-the-counter (OTC).
This can lead to the CFD being significantly mispriced relative to the live market, spreads being artificially widened during periods of volatility, significant slippage given the inability to assess the true market depth, and more.
In other words, while a CFD product may seem attractive at first sight as a result of the surface level narrow spreads, the lack of transparency about the sources of liquidity and how it is being priced and quoted is a significant downside, especially when it matters most (i.e. during volatility and abnormal market conditions). There is a significant lack of regulation in this area and CFD providers can, theoretically, do as they please as the majority of the flow is B-booked. This may include, for example, excessively widening spreads during volatile moves.
This is why Breakout uses Bybit’s liquidity for its crypto trading environment. The quotes are transparent and directly mirror a tier 1 centralized exchange. The market depth and available liquidity are also visible, including via the DOM (depth of market) built into our Breakout Terminal. We believe this is more transparent than a CFD alternative and offers more realistic trade execution.
Low fees and CFDs not only rhyme, but are usually bundled together.
The previous section outlined some potential risks associated with CFD trading, even if the spreads look very attractive at face value.
What about fees?
We do not believe the lowest fees necessarily make the best trading product.
Specifically, our claim is that artificially low fees are harmful.
There are two justifications for this.
First, the net cost of executing a strategy can determine whether the same strategy is profitable or unprofitable. If you’re trading a product with artificially low fees with a strategy that makes money, there’s a very real risk that the same strategy would not be profitable in the live market if the demo environment’s fees are significantly different. Accordingly, our view is that artificially low trading fees are misleading as they make inherently unprofitable strategies seem viable.
Second, prop firms cannot effectively hedge or A-Book those artificially profitable strategies. Even if the trader stands to theoretically benefit from ultra low fees and spreads that aren’t replicable in the live market, they only get paid if the prop firm has the capital to pay them. But if your trading environment rewards strategies that are impossible to deploy in the live market, then candidly, the prop firm becomes a charity for traders willing to steamroll their unrealistic trading conditions. If a firm can’t manage its risk, it can’t pay its traders.
This is why our crypto trading fees aren’t as close as possible to zero. Rather, Breakout’s crypto trading fees match Bybit’s taker fees to ensure that all trading strategies are viable in the live market and can be effectively A-booked (i.e. copied).. This, paired with our centralized exchange liquidity, makes our trading conditions more realistic, less misleading, and means that if you can trade well via Breakout, you can trade well anywhere.
While seeking the lowest fees may seem like a reasonable cost-optimizing pursuit, it may come at a risk to the trader (via making unprofitable strategies seem profitable) as well as a risk to the prop firm (by being unable to deploy those same strategies in the live market).
In summary, Breakout prioritizes realism.
Rather than quoting from opaque CFDs, our crypto trading environment verifiably mirrors liquidity directly from a tier 1 centralized exchange, even allowing traders to execute traders directly from the DOM.
Rather than racing to the bottom with fees with unrealistic and undeployable strategies, our fees are in line with centralized exchange costs of trading.
We believe this is fairer, more transparent, and better for traders.
Thank you for reading!
