They may widen spreads during volatility

In the foreign exchange market, the term “spread” refers to the difference between the bid price (what a buyer is willing to pay) and the ask price (what a seller is willing to accept). For retail traders, the spread is effectively the cost of entering and exiting a trade. Most casual investors understand that spreads tend to tighten during liquid, low-volatility conditions and widen when volatility spikes. But the real question is why market makers widen spreads during periods of volatility—and how this behavior, far from being a simple annoyance, is actually a critical mechanism for maintaining price stability and overall market structure.

To grasp this, you must first understand the role of a market maker. A market maker is a financial institution or individual that stands ready to buy or sell a currency pair at any time, providing liquidity to the market. They profit not from directional bets on price movement, but from the spread itself. However, this business model involves significant risk. When a market maker quotes a price, they are committing to fill an order at that price, even if the market moves against them before the order is executed. During volatile conditions—such as major economic data releases, geopolitical shocks, or central bank announcements—price movements become rapid and unpredictable. The risk of adverse selection, where informed traders exploit stale quotes, rises sharply.

Widening the spread is the market maker’s primary tool to manage this risk. By increasing the distance between the bid and ask, the market maker effectively charges a higher premium for the insurance they provide. This wider spread compensates them for the increased probability that a trade will be executed at a disadvantageous price. More importantly, it discourages aggressive, speculative trading that could exacerbate price swings. In other words, a wider spread acts as a friction that slows down the flow of orders, giving the market maker (and the wider market) time to react to new information. Without this friction, orders would pile up at stale prices, leading to gaps, slippage, and, in extreme cases, a complete breakdown of liquidity.

From a market structure perspective, this behavior is not a flaw but a feature. The foreign exchange market is decentralized, meaning there is no central exchange to act as a shock absorber. Market makers are the de facto buffer. When volatility surges, their instinct to widen spreads is a rational response that prevents them from being wiped out by a cascade of losing trades. If market makers were forced to maintain ultra-tight spreads during high volatility, they would quickly become net sellers or buyers of currency that is moving violently against them. The result would be a withdrawal of liquidity entirely—many market makers would simply cease quoting prices. This would lead to a liquidity vacuum, where buyers and sellers cannot find counterparties, and prices become erratic or even untradeable. The widening of spreads, therefore, is a self-preservation mechanism that ensures the market remains operational, even if at a higher cost.

For the active trader, this has direct implications. When you see spreads widen during a news event, understand that the market maker is not trying to cheat you; they are adjusting to a new risk reality. Trading during these periods can be dangerous because slippage becomes more likely, and the cost of entering and exiting a trade increases significantly. Advanced traders know to either avoid trading during scheduled high-impact news, or to use limit orders that will only execute at a specific price, rather than market orders that will fill at the current (and possibly unfavorable) spread. Additionally, traders should pay attention to the time of day. The spread widens naturally during the close of the major sessions, such as the London close or the New York close, because liquidity thins. During volatility, this natural widening is exacerbated.

The relationship between spread widening and price stability is counterintuitive but robust. A wider spread reduces the number of market participants willing to trade at any given moment, which dampens the speed of price discovery. In a liquid, stable market, this slowing is undesirable. But in a volatile market, it is essential. By making it more expensive to trade, market buyers and sellers are forced to be more deliberate. This prevents frenzied, emotionally driven trades from dominating the order flow. The price, therefore, moves in a more orderly, albeit costlier, fashion.

Ultimately, the market maker’s decision to widen spreads during volatility is a balancing act. They must maintain enough liquidity to keep the market functional while protecting themselves from catastrophic losses. This trade-off is the bedrock of forex market structure. For the trader, understanding this dynamic is not just academic. It informs when to trade, how to place orders, and how to manage risk. Recognize that a widened spread is a signal of elevated uncertainty, not a sign of a broken market. Adjust your strategy accordingly, and you will navigate volatile conditions with far greater control and profitability.