A differential represents the price difference between two related financial instruments, commodities, or market benchmarks. Differentials are commonly used in commodity markets to price regional varieties against benchmark grades, in bond markets to compare credit spreads, and in currency markets to analyze interest rate relationships between countries.

Understanding differentials is crucial for arbitrage trading, basis trading, and relative value strategies. Differentials can change due to supply-demand imbalances, transportation costs, quality differences, or changing market preferences. Traders monitor differential relationships to identify profit opportunities when spreads deviate from historical norms.

Real-world example: West Texas Intermediate crude oil trades at a $3 differential above Western Canadian Select due to transportation costs and quality differences, creating opportunities when this spread widens or narrows unexpectedly.