Spread Betting Explained
Financial spread betting is an increasingly popular way of making money on the financial markets offering the opportunity to trade on which way you believe a chosen market or share-price will go (higher OR lower). This is different from actually purchasing stocks and shares where a larger up front capital is required if you wish to take a similarly sized position within the market and can only typically speculate on a share going higher. Financial spread betting allows you to speculate on international markets all in the same currency, avoiding the need to make expensive currency exchanges.
Buy (Go Long), Sell (Go Short)
When you decide to make your first trade, you will not be buying the stock or share but rather you will be making a bet as to which way you think the market or share price will go. You can stake small or large amounts for each penny or point movement for which direction you believe the chosen market / share price will go. With each market you’ll be offered both a ‘buy’ price and a ‘sell’ price either side of the markets real world value (known as the underlying market). If you believe the market will rise you ‘buy’ (go long), if you think the market will fall, you ‘sell’ (go short). The difference between the ‘buy’ price and the ‘sell’ price is known as the ‘spread’. Spread Betting companies make their profit from this ‘spread’. Volatile markets will have a larger spread reflecting the risk and volatility of said market.
Long Positions: If you believe the share (or index, commodity or other asset) will go up, you buy at the offer price (the higher of the two prices)
Short Positions: This is a reverse of the above scenario while you are selling at the bid price
Advantages and Disadvantages
Spread betting has many advantages, one of which is that you can speculate on on a share price going down, something which you cannot do with traditional share dealing. For UK residents, spread betting has the added advantage of being free from capital gains and income tax. Any bet should be looked upon as a short to medium term investment as the longer you hold a position open for, the larger the spread becomes. Spread betting can also be highly risky as the potential for serious losses is quite real. That said, following some simple approaches to spread betting including the setup of ‘stop losses’ and ‘guaranteed stop losses’ should see you reasonably well protected.
Interestingly, sites offering spread betting should be authorised and licensed by the Financial Services Authority, however, for all intense purposes it is considered a form of betting, and as such any winnings arising from gambling are exempt from any tax. It could be debated whether this really is a form of gambling, but both spread bettors and spread betting companies are unlikely to argue.
A Bigger Share of the Market
Spread betting is a margined product, and it’s this that allows you to take on a much larger position in the market than you would otherwise be able to take, and thus make much larger profits (or losses!).
You only ever require a small percentage of the true value of your trades. For example, let’s say Barclays share price is currently running at 250p a share and you believe that it is going to rise so you decide to buy (go ‘long’). You bet £10 a point movement (1 point = 1p). Your exposure is technically 250 x £10 as you are betting £10 per point change, and there are 250 points, which could go down to 0 (although unlikely – we hope) if the share price were to go against you. Spread betting companies usually require only a percentage of the full value (a 10% margin in this example), meaning you require 25 * £10 to enter the bet, when in fact your true total exposure is the same as if you owned £2,500 of Barclays shares.
For volatile markets (the more likely the price is to jump up and down), the higher this deposit usually is.
A simple equation for you to remember: When spread betting shares, £1 per penny movement is the equivalent to owning 100 shares. £10 is equivalent to 1,000 shares, and £100 is the equivalent of owning 10,000 shares. You can see therefore that you can take a much larger position than what you could otherwise take if you were to purchase the shares up front.
Spread Betting Facts
• You don’t physically own anything during your time spread betting
• You predict which way your chosen markets or share price will move
• Choose from a vast array of markets (stocks, indices, commodities, bonds, etc.)
• Ability to make huge profits, but also huge losses due to the leverage offered
• You can minimise your risk by placing ‘stop orders’
• Take a position on international markets in your own currency
• Tax free profits for UK residents
Example Spread Bet
Hopefully you’ve watched the above video which gives a good introduction into spread betting. For arguments sake, here’s a spread betting example to help further our understanding:
You’ve looked at the different spread betting markets and decided you want to bet on the direction of the FTSE 100. You’ve been following this market and you believe it is going to rise after a recent dip. You’re ready to make your first spread bet.
Spread Betting Example
You decide to buy, or ‘go long’, as it is sometimes referred to. You decide to bet £10 on a per point rise at the current buy price of 5900.
Ideally you’d be looking to place a stop loss, which will help prevent any potential losses should the market go against you. We’ll skip this useful feature for now as it’s covered in more detail here. Spread betting companies usually require different deposits, but in this scenario for a £10 per point bet, a deposit of £250 is required (x25 deposit size).
Spread Betting Example
It’s been a good day at the market and it has risen nicely, the current sell price is at 5982 and the buy price at 5983.
You decide to close your position and take the profit. To do this you are required to ‘sell’. If you had bet on the market falling and sold (gone short), then you would be buying (going long) to close your position.
You will be selling for the spread betting companies sell price which stands at 5982.
Spread Betting Example
Now comes the fun part, working out your profit.
This is really simple. You originally went long at 5900 for £10 per point rise. You went short at 5982 to close your position and reap the profit.
5982-5900 = 82 (82 x £10) = £820 profit. Not a bad days trading for a newbie.
Well, in this scenario things went well. However you put a stop loss on at 100 points below the current price, had the market fallen to this level you would be £1,000 out of pocket and possibly more if your stop loss wasn’t guaranteed. You can find out more about spread betting stop losses and how to mitigate your losses here.