Spread betting explained
Spread betting began in the United Kingdom in the 1970s. It is a different way of trading. Here, you don’t have defined win or lose outcomes because there are no fixed odds. You speculate on the price movements of thousands of instruments and securities. Your accuracy decides your profits and loss. Let’s understand each component of spread betting.
The spread is the difference between the buying price and the selling price of an instrument. It is the range of outcomes.
So, what is Spread Betting?
Spread betting is a tax-free financial derivate process where participants place bets on the price movement of security such as forex, indices, commodities, shares, etc. Spread betting is recognized as a form of gambling under the law of the United Kingdom because in spread betting the investor does not own the asset, only speculates on the direction in which the price of the asset will change, either decrease or increase. If the investor’s price prediction is correct, he could make a profit, else he will make a loss. This makes spread betting a financial derivative product that is tax-free. It allows the investor to speculate on multiple financial markets like commodities, bonds, forex exchange(forex), indices. Since the investor does not purchase the asset, he can profit from both rising and falling markets and has more opportunities compared to conventional investing.
In spread betting, you don’t buy any physical commodity but speculate if its price will go up or down. You hold positions in this kind of trading. You will hold a long position if you believe that the prices will rise and a short position if you believe that the prices will fall. All the sales and purchases are made at a pre-determined amount per point of price movement. This is also known as the ‘stake’ size. Depending on the direction of the price movement, you gain or lose in the multiples of your stake. Here is an example that will make this clear:
The Asset price is 100.
The bet stake per every pip is $5.
If the exchange rate increases from 100 till 104 then the trader’s profit will be 4×5=$20,
If the exchange rate increases from 100 till 96 then the trader loss’s will be 4×5=$20.
Let’s assume that you are holding a long position and bought a commodity at a pre-determined amount per point of $5. It does not mean that you bought a single unit of that commodity at this price. It means that you will gain $5 every time the price movement will rise by a point and will lose the same amount per point if it goes down. Suppose the price of the commodity rises by 4 points, you will gain four times your stake size, that is, $20.
Spread betting main features
Short and long trading.
The investor can bet that the underlying asset will increase in price, which is called ‘going long’. Alternately he can open a spread bet which will make a profit if the asset price is reducing, which is defined as “going short”. The loss or gain of a spread bet position depends on the extent to which the prediction is correct. An investor who wishes to take a position can practice trading using a demo account or open a live account for spread betting.
Spread betting Leverage
One of the most important aspects of spread betting is the leverage which allows traders to get full exposure to the financial market, at a price which is a fraction of the cost of the asset. For example trading in the shares of a top company is very expensive, since the shares are expensive. However, if the investor decides to spread bet on the shares of the company, he may only have to make a deposit which is 20% of the share cost. Investors should be aware that leverage will magnify the losses and profits of the trader since the full position value is considered for calculation, not just the initial deposit. Hence the trader should have a strategy for managing risk, and consider the entire capital amount which is at risk.
Spread betting margin
When an investor is opening a position for spread betting, the small deposit made initially, usually, a percentage of the full trade value is called the margin. Hence leveraged trading is also called margin trading. For spread betting, the investor has to consider both the maintenance margin and deposit margin. The deposit margin is a percentage of the total trade and is the funding required initially for opening a position. If the open position is making a loss that is not covered with the deposit made initially, additional funds are required which are the maintenance margin. The investor will usually get a notification from the broker asking him to add funds to the account used for spread betting. This notification is called the margin call. If the investor does not pay the amount, the position will be closed, and loss in the account recovered.
What is the spread betting process?
In finance, there are three components in spread betting. The spread is the charge the investor will pay for opening a position, the bet size which depends on the capital amount at stake, and the duration of the bet, which determines how long a particular position remains open before expiring.
The difference between the sell and buy prices is the spread, which is linked to the related market prices. These prices are called the offer and bid prices, and incorporate the cost of trading. Investors will purchase at price slightly more than the market price and sell at a price lower than the market price.
Bet size is the amount the investor bets for every unit of movement in the related market. The investor can choose the best size, provided it is more than the minimum acceptable for the market. The loss or profit is calculated by multiplying the bet size, with the difference in the opening and closing price for the market. Price movements in the relevant financial market are measured in terms of points. Depending on the financial market chosen, the point movement may correspond to a pound, fraction of a penny, or penny. The investor should find out what a point for the selected market means
The length of time before the investor’s position expires is called the bet duration. The timescale for all the spread bets is fixed, though the duration varies from many months to a day. However, the investor may close the bet any time before the expiry time if trading for the spread bet remains open.
The daily funded spread bets will run for as long as the investor keeps them open. They offer the tightest spreads available, and the default expiry date is some time away. The broker will adjust the balance considering the funding costs for the position, for every day, the bet remains open. Investors speculate on market movements in the short term using daily bets.
Quarterly bets are bets on futures that expire at the quarterly period ended. The funding costs are included in the spread of these bets. The quarterly bets can be rolled on request to the next quarter, by informing the broker.
Like all other forms of trading, spread betting involves some amount of risk, so investors should not risk more than what they can afford to lose. It is possible to hedge a spread bet. This is done by opening a betting position which will offset any price movement which is negative in the existing position. This is done by speculating on an asset, which will move in the direction opposite to the existing trade. Hedging is an effective way to reduce risk or limit the losses to the amount the investor can afford.
When an investor is buying and selling shares, the investor will have to pay stamp duty on the purchase, and capital gains tax on the profit, but for spread betting, no taxes have to be paid. Since the investor does not own the asset, no stamp duty has to be paid. Investors should be aware that it is not possible to do spread betting without leverage, it is a very integral part of spread betting. Hence the investor should formulate a suitable strategy for risk management before spread betting.
Do You Need a Spread Betting Broker?
Spread betting is not like your traditional trading. There are no restrictions on the stake size. There are numerous spreads and each spread is fundamentally different from the other. Spread betting is trickier. So, in short, the answer is ‘yes’. You should do spread betting with the help of a trusted broker.
There are a number of brokers who are available to guide you. You can choose from a number of instruments like cryptocurrencies, Forex, stocks, indices, bonds, shares, treasuries, and commodities. Your broker will guide you through it all.
Top Spread Betting brokers are:
Finding the Right Spread Betting Brokers
These are the qualities that good spread betting brokers should possess:
It is natural to expect the safety of your money as an investor or trader. Being regulated is a must. Your broker must be under strict local regulation. Established brokers are also regulated in major EU economies like Germany, or the UK. The Financial Conduct Authority (FCA) is the regulatory body in the UK. Various brokers across the world aim to obtain the FCA license as it is considered to be a benchmark. If your broker has one, it is a good sign.
Regulated brokers are prohibited from using their clients’ funds for the operational use of the firm. Even in the case of insolvency, your broker cannot withdraw your deposit for its benefit. This ensures the safety of your investment.
Many regulatory authorities like the FCA prohibit brokers from giving financial advice to their clients. If your broker is making suggestions beyond the suitable spread bet, they are not regulated.
2. Brokers and Interest Rates
Long-term traders have an advantage over short-term traders. Since they invest more, they can also borrow more. Many long-term traders are offered capital by the brokerage firms for trading. Know the rate of interest that your spread betting broker is offering.
3. Market Diversification
Along with having profound knowledge of spread betting, it is also crucial that your broker offers you a variety of instruments that you can trade. Spread betting can be done on cryptocurrencies, currency pairs, stocks, indices, bonds, shares, treasuries, and commodities. Having these options is a plus point.
4. Trading Platform
There are various trading platforms to choose from but the best spread betting platform is considered to be MT4. Its features are more suitable for this kind of trading. Good spread betting brokers use the MetaTrader4 platform.
5. Customer Care Service
Your broker will not be available to you at all times. In their absence, you must have a company representative who can guide you. Having a good customer care support system allows the brokers to be constantly in touch with their clients. Look for a broker that offers round-the-clock customer care and in different languages.
6. Experience and Knowledge
Ideally, you should trade with a broker who has been providing services for atleast two years. When it comes to spread betting, there is more to just the number of years. Spread betting can save your taxes. Your broker must have years of experience and knowledge to guide you in the best way possible.
7. Minimum Deposit
Just like traditional trading, keeping a minimum deposit with a broker is necessary for spread betting as well. The amount may vary from broker to broker. You must consider your budget before requesting an account.
Withdrawals can sometimes take longer than a week. This means that you have to wait for a longer time for your money. Certain brokers even charge you a withdrawal fee. Ask your spread betting broker about all the charges involved.
Many traders and brokers believe that spread betting is a revolutionary way of trading. It is different than traditional trading where you buy a certain commodity with the hope of selling it at a higher price for profit in the future. Spread betting is all about the difference in the buying and selling price of the commodity. We would like to highlight that this is not suitable for beginners as there are several spread types involved that are hard to comprehend. Always do spread betting with the help of a trusted broker.