Spread betting is a derivative product which is used to speculate on financial markets, including forex, indices, commodities or shares. With spread betting, you do not take ownership of the underlying asset, you place a bet on whether you think the price of the asset will increase or decrease.
Financial spread betting has been around since the 1970s and its growth in popularity can be attributed to the fact that spread betting is leveraged, which means you can open a larger position with a small deposit or margin. Spread betting also provides a much wider range of opportunities than traditional buy-and-hold investing and is tax-free in the UK.
Trading the markets in this way is highly competitive and requires a lot of learning and practice. Taking a methodical approach and gaining a good understanding of the risks that often lead to losses can help you improve your odds of making a profit.
How does Spread Betting work?
Unlike traditional buy-and-hold investments, spread betting works by using bets instead of buying and selling assets. So rather than buying shares in a company and waiting for them to increase in value before selling them to release the profit, you would place a bet on that company’s shares increasing in value.
If the price of the shares continues to grow, your profit will continue to increase. Profit is calculated on the number of points the market moves, but if the share value falls and continues to decrease in value, your loss will be greater.
For example, you place a ‘spread bet’ that a company’s share price will increase and the current share price is 220 , you opt to go long with £10 per point at 220. If the share price increases to 225, you will have earned £10 for every point, giving you a total profit of £5. If the share price had fallen by 5 points, you would lose £50.
When you open a spread bet, there are two prices listed – the ‘buy price’ and the ‘sell price’. These two prices can help you decide whether to go long or short on your bet. You will select buy if you think the price is likely to increase, or select sell if you think the price is likely to decrease.
To close a spread bet you have to trade in the opposite direction that you opened it. For example, if you bought at the start you would sell to exit the bet and vice versa. There are some basic principles of spread betting that can help you improve your chances of success, including:
- Cutting losses early – losses can multiply quickly, so minimising them early can help prevent significant losses.
- Limiting position size – leverage gives traders the chance to scale up their positions with a smaller cash balance than other types of dealing. Therefore, position sizing becomes a paramount concern as potential losses are also multiplied.
- Making a trading plan and sticking to it – without a plan emotions can get involved and affect your decision making. Be clear on your entry and exit points and stick to them.
- Avoiding over trading – ensure you have enough time to manage your investments effectively and avoid investing in too many different stocks at one time.
- Diversifying your profile – holding a large proportion of a portfolio in any one stock or financial instrument can be very risky. Spread your bets across different sectors to help minimise risk.
Types of Spread Betting
One of the major advantages of spread betting, is that there are a number of different types of spread betting options, and they fall into two primary categories – spread betting across different time frames, and types of spread bet orders.
When it comes to spread betting across different time frames, there are four main types which are offered, and these are:
- Daily spread bets – bets that automatically close at the end of that trading day, but can be closed at any time prior to the end of the trading day.
- Rolling Dailies – the most common type of spread bet. Instead of closing at the end of the trading day they roll over to the next trading day until the bet is closed.
- Futures spread bets – a popular choice among traders who like taking medium-term positions, most futures spread bets have standardised expiry or delivery dates (such as a chosen month) but can also be closed at any point before it expires.
- Binary Bets – these are different to the other types of spread bets in that they are an all or nothing bet. Rather than your profit or loss being based on how many points the market moves, with a binary bet if you are successful your profit equals the full amount of your bet and if you lose your losses are the total amount of your bet.
In addition to placing spread bets on different time frames, you can also use a variety of order types, including:
- Market orders – this type of order is executed immediately after being placed and at the best available spread price, which cannot be guaranteed in fast moving or volatile markets.
- Limit orders – these orders specify a certain price and are only filled at that price or better.
- Stop orders – used to manage risk and limit loss on an existing spread bet. You can enter a stop-loss order to automatically close after your bet has lost a specified number of points. Although it does not guarantee it will stop exactly at your stop price.
Advantages of Spread Betting
There are many advantages of spread betting such as:
Spread Betting is tax-free in the UK
All bets and profits made from spread betting are tax-free, including capital gains and stamp duty. This means you are not obligated to report any profits or losses to HMRC from spread betting. These tax rules will change depending on your employment status, spread betting is only tax-free if it is not your main source of income.
Spread Betting is a leveraged product
This means you can use a relatively small deposit to control a larger value trade. This works by the trader only having to pay a percentage of the full value proposition to open the trade, this amount is known as the margin. For example, if you wanted to buy £10000 worth of shares on the stock trade you’d have to pay the full amount upfront, but with spread betting you would only pay 20% or £2000.
Spread Betting is regulated
Spread betting is regulated in many countries including the UK, France and Germany. This gives traders peace of mind that their rights and money are protected from a range of situations and helps keep traders safe from spread betting scams. In the UK spread betting is regulated by the Financial Conduct Authority (FCA).
Disadvantages of Spread Betting
As with all types of investments, there are also disadvantages that you should be aware of before making the decision to begin spread betting, including:
If you do not manage your risks and position effectively you can suffer significant losses. Trading on a margin can multiply your losses and they could end up exceeding your initial investment, meaning you could owe more than you originally placed on the spread bet. Also knowing when to exit is key to limiting your losses.
Spread betting markets move fast and can be volatile, making them a fast moving place to trade. Which is great when they are moving in your favour, but also means your losses can amass quickly in a short period of time when they are moving against you.
Expensive bid-offer spreads
Some brokers make up the money they lose through offering zero commission fees by using expensive bid-offer spreads. It’s crucial that traders do their research and shop around to find a competitive broker before they begin spread betting.