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Describe how the rise of electronic trading has affected trading costs (spreads)?

Describe how the rise of electronic trading has affected trading costs (spreads)?

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Answer #1

Spreads are the difference between the bid price and the ask price.

Spreads are indicative of the liquidity of the market. Highly liquid markets have low bid-ask spreads.

The  rise of electronic trading has helped make markets more liquid, and this has brought down trading costs (spreads). This is because with electronic trading, the bid-ask spreads are narrowed. The reason is that electronic trading facilitates quick arbitrage of anomalies. If a bid-ask spread is found to be too high, market participants can leverage electronic trading to make arbitrage profits. This drives down the spread until it reaches an equilibrium level.

Electronic trading facilitates securities market makers to offer lower bid-ask spreads because market makers face lower risk and higher execution capabilities.

In this way, electronic trading has helped lower trading costs

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