Spreadbetting is one of fastest growing trading products in the UK. Financial Spread Betting is traded on margin, making it a highly efficient way for day traders to utilise limited capital and speculate on the financial markets. Traders have the opportunity to speculate on a financial instrument without having to actually own the asset. In this section we explore the workings of financial spread betting and explain the mechanisms of spread betting.
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Financial Spread Betting Explained?
Spread betting originated in the sports arena, but now has become very popular in the financial markets. It was a way for the bookmaker to profit on either side of the bet, regardless of the outcome. This is in contrast to traditional betting, where the bookmaker had to make odds to try and balance the sides, and risked being out of pocket if the odds were not right.
How does Spread Betting Works?
Stated simply, spread betting allows you to place a bet on whether a price will rise or fall. However, it is not a fixed bet, such as you might place on a horse race, but the value varies according to how much the price changes. It is a bet, which means that in many countries, such as the UK, a profit is regarded as winnings and capital gains tax does not apply. This is one of the several advantages of spread betting.
You’ll also find that, unlike financial trading, the spread betting provider or broker does not charge a commission for the transaction. The profit for the bookmaker is in the difference between the price when you bet the price will rise, and the price when you bet that it will fall. This difference is called the “spread”, which is where we get the name.
Financial spread betting explained. Spread betting is speculation on the direction of the price, but does not involve buying or selling any financial securities. This means, for instance, that when you are spread betting on shares there is no liability for stamp duty. It also means that spread betting can be easily applied to many different financial instruments, not just shares. Depending on the spread betting provider that you use, you will typically be able to spread bet on currencies, commodities, and market indices such as the FTSE 100, as well as on individual shares. Many providers allow you to spread bet on shares globally, including those on the American and other markets.
One of the great attractions of spread betting is that you can get started very cheaply. Essentially, you can name your own price for the bet and it can be as little as £1 per point. It multiplies the value of your money, which is also known as gearing or leverage. However, unless you know what you are doing it is easy because of leverage to lose more than you intended – a risk that does not exist in conventional share-dealing.
The amount you need to deposit depends on the liquidity and volatility of the underlying financial instrument you wish to trade. Generally speaking this can range anything from 1% to 25% of the underlying market exposure and is referred to as ‘notional trading requirement’.
When opening a spreadbet you place a stake per point which makes up each incremental movement in the price of the instrument you are trading and your consequent gain or loss will depend on the points difference between the opening bet and closing spreadbet multiplied by the value of your bet per point. With stocks listed in the United Kingdom one point is equivalent to a 1p movement.
Here’s an example of a spread bet. You ask your spread betting provider for a quotation for company ABC, and he responds with 3432 — 3442. In share dealing terms, this would correspond to the shares selling at £34+, the spread betting prices usually bracket the last traded price. If you think the price is going to increase, you might place a spread bet for £5 per point, and this would be at 3442.
A little later, your broker quotes the same company at 3651 — 3661, and you decide to take your profit. You sell the bet at the lower number – this is where the broker makes a profit – for a 209 point gain. At £5 per point, this is £1045. It is as straightforward as that.
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Having looked at the principles of spread betting, it’s now time to go through the details of how it works which might be best demonstrated by a spread betting example. Spread betting on the financial markets allows you to profit whether the prices go up or down, provided that you anticipate that correctly, and also to leverage the power of your money to multiply your gains.
When you go to place a spread bet, the spread betting provider will quote you two prices for any particular financial security that you want to bet on. The difference between the prices is called the spread, and as you’ll see the price has to change in your direction by the amount of the spread before you can make any profit.
If you think that the financial security, whether it is a stock, an index, or something else, is going to increase in value then you place your spread bet based on the higher figure. Your spread bet will be subject to the broker’s minimums, but is possibly £1 or a multiple per point that the price changes. When you come to close out your long spread bet then it will be on the basis of the lower of the two figures that you are quoted by your broker at that time. Effectively, you are buying at the higher price and selling at the lower price.
This means that as soon as you enter the trade you have lost money, as you can only sell back at the lower number. When the price has increased by the amount of the spread you will have broken even. That is the way that your spread betting provider makes his living, and it also means that you do not have to pay a separate commission every time you trade.
This is the reason that there is so much emphasis on the size of the spread. A lower spread means that your trade has to increase by a lesser amount before you start making a profit, so is a good thing. If a broker quotes you a wide spread, then he’s going to make more profit from you and it will be more difficult for you to make as much profit as you want.
Now we can consider the opposite bet. Suppose that you think the underlying financial instrument, say the FTSE 100 stock market index, is going to fall in value. You would ask your broker for a quote on the FTSE 100, and again he would give you two figures with the difference between them being the spread. Because you think the price is going to drop, when you place your spread bet you would first “sell” at the lower number. The bet you place will again be a certain number of pounds per point, this time looking for the quote to fall.
If the index drops as you anticipate, you would close out your position by buying at the current higher number, and the number of points difference times your bet will give you your profit.
There are lots of spread betting companies, Capital Spreads, IG Index, City Index, etc, etc. Most have a demo account which enables you to place bets with imaginary money hence no actual loss or gain but enables you to learn.
I would strongly advise against betting using a credit account, it’s to easy to get into debt. Far better to place money in the account which limits any loss to the amount in your account.
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So what is Financial Spread Betting anyway?
Spread bets are a mix between traditional betting and contracts for difference or CFDs -:
- TRADITIONAL BETTING: Taking a position on what you think the outcome of a situation will be.
- CFDs: Buying the stake of a financial market without actually purchasing the underlying product.
With financial spread bets, you can speculate on whether a specific financial market will increase or decrease in value. So, unlike traditional financial products, which typically only allow you to buy, spread bets can be entered as either buy or sell trades. You trade stakes of the underlying instrument price, but never actually own any part of that instrument.
Because of this, you can leverage your trades, or put up a small portion to cover a larger position. However, leverage can cause substantial losses as easily as it can help produce substantial profits, so make sure you are always managing your risk. You also avoid any additional commissions and fees, as these are included in the spread. Now let’s take a quick look at how spread bets differ from other financial instruments.