What is Spread Betting?

Posted By Robert On Sunday, September 7th, 2014 With 0 Comments

What is financial spread betting? In a nutshell, pread betting is a service where you can have a bet on whether the price of a financial asset will increase or decrease. Spread betting is different to traditional forms of financial asset trading in that you never actually own the asset, you just have a position on whether the market price of the asset will increase or decrease in value. This allows leverage, so your position can be greater than the amount of money you would be able to spend on tradition financial products.

Financial spread betting as such is basically betting on whether a market will go up or down.   In the UK, spread betting is tax free and leveraged, which essentially means that you can bet with just as little as £100. With each trade, the spread betting provider offers you the option to ‘buy’ or ‘sell’ on either side of the market price. A trader who decides that the market will rise would take a long position (open the bet at the ‘buy’ price) – conversely if the trader decides that the market is likely to fall would open a trade at the ‘sell’ price. The more the market moves for or against your position, the bigger the profit or loss.

Spread betting is leveraged trading (in other words trading on margin). Instead of paying the full market value, you put up an initial deposit. If you get the market direction right and the bet goes in your favour, you stand to make substantial monies from a relatively minor stake. In fact, spread betting normally uses 5% to 10% deposits to leverage larger bets.

The spread refers to the difference between the buy and sell price, and so the smaller the spread, the less the deficit is at the beginning of the bet.

Please note that spread betting involves significant risk and you may lose more than your initial deposit. It is not suitable for everyone.

How does it work?

To answer this question, it is best to use an example, such as a spread trade on the price of a share. You research the share price of a company that you are interested in e.g. Microsoft. You will have an opinion that the share price will either increase or decrease in the future. If you think the price will go up you “buy” the share price. If you think the price will go down you “sell” the share price. If your opinion is correct, you will make a profit, but if your opinion is incorrect, you will make a loss.

How do I calculate my profit or loss?

Shares on the London Stock Exchange are priced in Pounds Sterling and pennies. In spread trading, each penny is given a value. You decide what value each penny should have. Let’s assume you decide to give each penny a value of £10. Then, for every cent the share price moves up or down, you make a profit or loss of £10. You could, of course, give each cent a value greater or less than £10. It depends on the level of risk you are prepared to take. The bigger the value given to each cent, the bigger the potential reward and the bigger the risk.

Say the FTSE is quoted at 5046-5047. If you think it’s going up you buy at 5047, using a sell stop somewhere below to protect the account. If it goes the right way you make a profit for every point, to the value of the trade. Selling is the opposite.  So if you buy £10 per point and it goes 20 points you are up £200. You close the trade by selling for the same value you bought at. Firms should have a one point spread for FTSE, and allow a minimum of a pound a point.

How do I commence trading?

To commence trading, you need to first open an account with a spread betting provider. This can be done by telephone or online and only takes a couple of minutes. You then need to deposit funds to this account. You are now ready to commence with your first trade. Every trade carries a potential profit or loss.The amount of funds required in your account to place a particular trade is explained on the Market Information page.

Could I make a loss?

Like any investment, losses may be incurred. However, you can take action to minimise these losses. When recording your trade with a provider, you can state the maximum you are prepared to lose. This is called a “Stop Loss” and your position is automatically cut when you reach the loss limits you have specified.

In addition, a loss making trade can be terminated at any time, thus limiting any potential losses. You can stop the extent of the loss immediately by a phone call or by placing a ‘counter’ trade online. This is called “closing your position” and it is instantaneous, no waiting to contact a broker or hoping to find a buyer for your shares.

Share Trading Example:

Let’s assume you wanted to take a position on Vodafone for £5000 worth of shares; with a stock broker you would need the full £5000 to open this trade. But with a spread betting provider requiring only 5% margin, you would open this same position with GBP100 in your account. If Vodafone spikes up by 10% in the direction of your trade, you could make £200 for having £100 tied in. The more right you are, the more you could potentially make. Of course this cuts both way and if the market moves against you by 10% you would be looking at a GBP200 loss and would need to put up some more funds to cover. As such it is important to understand what you’re doing and that losses could add up to an amount in excess of your initial deposit.

Index Trading Example:

Let’s say that you have a view, say, that the FTSE 100 is likely to push higher up. The index closed one particular day at 6,500. A spread betting provider might quote you a spread of 6499-6501 on this market. You believe the market is going to move up, so you buy the FTSE 100 at 6501. You choose to bet £10 on this. The FTSE 100 starts moving up – at 6521 you have made 20 points profit which at £10 a point adds up to £200 (that is, 6,521 minus 6,501, multiplied by £10). It keeps climbing over the next week reaching 6560, at which stage you decide to close your trade having made 59 points at £10 a point = £590.

But let’s assume for one moment that you get it wrong and instead of the FTSE moving up, it fell after you buy at 6501. It drops to 6475 and you keep hoping, and it keeps falling down to 6450. Now your losses are £10 x 51 = £510.

As you can see, with this type of betting, gains/losses are not fixed from the outset – they increase the more right or wrong you get the prediction. i.e. all trades are geared with your stake buying you exposure to a larger market position that you would normally be able to buy.

This kind of trading is riskier than buying shares but the risk can be reduced by the use of stops.  If you get your bets wrong, you will lose money. In the FTSE example above you could have limited your losses by setting a stop loss to your trade which would automatically close your bet at a pre-determined level, limiting losses.

This is not investing but speculating on short-term market movements. There are more than 90,000 people in the UK who utilize spread betting.

Reasons to start spread betting:

  • It is tax free unlike dealing in conventional shares where you have to pay CGT.
  • It is a quick and easy way to access thousands of different markets including indices, commodities, currency pairs and shares.
  • Bet on (and profit from) shares rising or falling in value. This essentially means that it is still possible to make money even when others are losing.
  • It is not difficult to understand and most spread betting providers have developed apps permitting one to trade on the go. You can access your trading account from a desktop computer or smartphone.

In practice the same principles apply irrespective of the underlying asset on which a spread bet is based. However, many traders tend to prefer to trade markets they are familiar with with the most popular markets being FTSE 100 index, the Dow Jones industrial average, and the German Dax index.

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