What is Financial Spread Betting?
The basic principles of financial spread betting involve predicting the movement of a financial market or asset, but without owning the underlying asset. Fundamentally, you are placing a bet on whether the asset will go up in price or down in price.
How Does Financial Spread Betting Work?
A broker quotes a spread for a particular market or asset. The spread represents the difference between the buying price and the selling price.
Traders place a bet on whether the actual outcome will be above or below the spread. The size of the bet is related to the trader’s stake, which is the amount they wish to risk ‘per point’ of movement lin the market or asset.
If the market or asset moves as the trader predicted, then they will be in profit. If, however, the market moves against them, then they will be in a loss-making position.
Key Concepts of Financial Spread Betting
The spread is the difference between the buy and sell prices. The spread buy and sell quotes sit either side of the asset’s underlying market price. Sometimes these quotes are referred to as the ‘offer’ and ‘bid’. The cost of any trade is built in to the spread, so when you buy it is at just above the market price and when you sell it is at just below the market price. Spreads can vary but are generally ‘tight’ on major assets.
This diagram below should help you visualise how it works:
The size of your bet or stake is the amount that you want to bet ‘per point’ or unit of movement, on what ever asset you are trading. A ‘unit’ might be a pound, a penny, or a fraction of a penny, so it is important to keep an eye out for what the value of a ‘point’ is when you come to submit your bet. It is quite self- explanatory when you get to that stage.
The size of your stake or bet can be as large or as small as you like, as long as it meets the requirements for that market. You’ll find most broker minimums are 50p to £1.00, sometimes less, depending on the asset.
Your profit or loss will be based on the opening or closing prices of the particular market that you are trading, multiplied by your stake.
We’ll get to some proper examples later on, but this might help to give you the general idea regarding stakes and market movement. In the diagram below, the stake is £10 and the market movement is 25 points. Depending on whether the market movement went for or against you, you would win or lose £250.
The duration is the amount of time that passes before your bet or trade expires. Spread bets have fixed time periods ranging from a day to many months. You can of course close your position at any time (during market trading hours) before the expiry point. In theory a spread bet can run for just a few seconds, to years if you are prepared to roll over your position.
Financial Spread Betting Examples
We’ll say the FTSE spread is 7105-7110, meaning that the spread betting company thinks the index will be between 7105 and 7110 points. You decide to place a sell bet of £2 per point at 7105, meaning you’re betting that the index will go lower than 7105 points. If the index spread quote falls to 7050 points, you’ll make a profit of £110 (55 points below ‘sell’ spread quote x £2 per point stake). However, if the index quote rises to 7150 points, you’ll lose £90 (45 points above the ‘sell’ spread quote x £2 per point stake).
You decide to place a buy bet on the price of gold. The spread might be 1275-1280, meaning that the spread betting company thinks the price of gold will be between £1275 and £1280 per ounce. You decide to place a buy bet of £5 per point at 1280, meaning you’re betting that the price of gold will be higher than £1280 per ounce. If the price / quote for gold rises to £1295 per ounce, you’ll make a profit of £75 (15 points above the ‘buy’ spread quote x £5 per point stake). However, if the price / quote of gold falls to £1265 per ounce, you’ll lose £75 (15 points below the spread ‘buy’ quote x £5 per point stake).
You want to place a buy bet on the pound / GBP against the US dollar / USD. The spread is 1.3850-1.3852 meaning that the spread betting company thinks the pound will be worth around $1.3851. You place a buy bet of £10 per point at 1.3852, meaning you’re betting that the pound will be worth more than $1.3852. If the price / quote rises to $1.3900, you’ll make a profit of £480 (48 points above the spread ‘buy’ quote x £10 per point stake). However, if the pound / quote falls to $1.3820, you’ll lose £320 (32 points below the spread ‘buy’ quote x your £10 per point stake).
The diagram below should give you some additional context regarding the above examples:
More Financial Spread Betting Features
- Going ‘Long’ or ‘Short’: Going long simply means that you are betting on the market or asset going up in price over a certain period of time. If you go short (also known as ‘shorting’ the market) you are betting on the market or asset going down in price over a certain period of time. Going short is not something that you can do when investing in the traditional way of buying and owning stocks and shares. Spread betting therefore holds certain advantages and opens up new avenues of investing.
- Leverage: Leverage gives you the opportunity to gain full exposure to the market for a fraction of the cost. If you were buying traditional stocks and shares you would have to immediately pay for the full cost of the asset. With leverage in spread betting, you might only have to put down as little as 20% of the cost. Remember, however, that leverage exposes you to potentially increased profits and losses, so it’s important to employ good risk management techniques (discussed later).
- Margin: Leveraged trading is also known as ‘margin trading’. This means that you put down a small portion of the bet as a deposit to open a position. This is the margin. There are basically two types of margin:
Deposit Margin: This is set at a percentage of your total trade and opens your position.
Maintenance Margin: This refers to the fact that you may need to ‘maintain’ your position by adding extra funds, if your trade begins to incur losses that are not covered by your deposit. In these circumstances you will get a ‘margin call’ requesting that you add funds. If you don’t, then you risk having your position closed. Margin rates differ depending on the asset.
- Stop Loss: Stop losses are a way in which to control your risk in the market. You can set a level where your trade or bet can be closed out for a loss, if the market moves against you. ‘Stops’ allow you to work out your maximum expected loss based on your chosen stake.
Guaranteed Stop Loss: During volatile periods, the market can be vulnerable to ‘gapping’. In these fairly rare circumstances things can happen too quickly for regular stops to ‘hold’ and you may be ‘stopped out’ at a worse level than your original stop loss. Guaranteed Stops ensure that you’ll be stopped out at your chosen stop level, even if the market suddenly ‘jumps’, ‘gaps’ or even ‘crashes’. Unlike regular stops, your stop level is ‘guaranteed’. Whenever I trade, I always use a guaranteed stop. It costs a little more on the spread but is well worth it as it can avoid a ‘catastrophic loss’. Having said that, I have only experienced a small ‘gap / jump’ once.
Your order slip will look something like this (courtesy of Spreadex). Note all the options for stop loss, guaranteed stop loss and limit order (discussed later).
Trailing Stop Loss: These types of stop loss are not set at a fixed level like standard stop losses, they are set at a specific number of points or certain percentage below the asset price. The stop-loss then ‘trails’ behind the asset price as its moves upwards (going long) or risks bring hit or ‘triggered’ if the price moves downwards.
Trailing Stop Example: You buy an asset at £20 per point and set a trailing stop loss at 15% below the market price, at £17. if the price falls to £17, the stop will be is triggered and the asset is automatically sold because the price has dropped 15%. However, if the share price rises, the trailing stop rises with it, remaining 15% below the current asset price. So, if the share price rises to £30 your trailing stop level would automatically rise to to £25.50. This would give you a potential profit of £5.50 (Trailing stop level £25.50 – Intial buy price £20). If the share price then dropped to £25.50, your trailing stop-loss would kick in and your profit of £5.50 would be realised.
Here is another diagrammatic example with a £10 stake and a 10% trailing stop loss:
In the diagram above the stock rises to £15 from the initial buy price of £10, before falling to trigger the trailing stop at £13.50, for a £3.50 profit.
5. Limit Orders: These are used to set a level at which you would like your trade closed out for a profit. If you like, you can trade in a ‘set and forget’ manner, by setting a guaranteed stop and a limit. You will then, eventually, either be stopped out for a loss or closed out for a profit.
Advantages of Financial Spread Betting
No Capital Gain Tax
Currently, any profits you make through financial spread betting in the UK are not subject to Capital Gains Tax (CGT). Be aware, however, that losses can’t be offset against profit from other sources.
Whilst profits made from spread betting do not count towards your Capital Gains allowance, any losses cannot be offset against profits elsewhere.
The way you are assessed for tax depends on your particular circumstances and jurisdiction. Laws may change in the future.
Financial spread bets are not subject to Stamp Duty.
When you buy shares from a stockbroker, you get charged Stamp Duty on the value of the shares, this is not the case with spread betting.
Again, tax treatment depends upon individual circumstances. Relevant laws may change going forward.
You can transfer assets to release cash.
You can convert stocks or a portfolio of stocks into a spread bet and release your cash. Say, you hold 3000 shares in a stock at £8 a share, with a total value of £24,000. You could put down a small margin e.g. 5% and convert your stocks into a spread bet, thereby releasing your cash. Based on 5% margin, you would put down £1200. This would free up £22,800 in cash.
You would be expected to have good credit. Also, such transactions are usually subject to opening commission fees and ongoing roll and funding costs. Remember though, that you would have the released cash in hand and the CGT tax advantages that apply to spread betting.
Financial spread betting can be used to hedge your stocks and shares portfolio.
If, for instance, you owned shares in BP and were worried that they might fall in price, you could sell BP as a spread bet to offset any potential loss. In this scenario you wouldn’t need to give up the stock itself, thereby avoiding having to pay potential Captial Gains on any profit you’d made on the shares to date.
Before You Start Financial Spread Betting
Spread betting can be a profitable way to trade on the financial markets. Here are some tips that may help you become more successful.
- Understand the basics of spread betting at the very least. Know the requirements in relation to margin and how to place trades. Know your downside.
- Have a trading plan. Know your risk management strategy and exit criteria. Understand the assets that you are trading.
- Use Analysis Tools: Spread betting companies use top of the range research and analysis tools, ususally free of charge. Use them to identify trends and key market levels.
- Risk Management: This is a one of the most important parts of spread betting. Don’t risk more than you can afford to lose. Use stop losses. Remember with spread betting you can lose more than your stake.
- Emotions: Don’t get attached to trades. Stay calm and objective. Stick to your plan, unless you see a strong opportunity to let your profits run.
- Practice: Almost all spread betting companies offer demo accounts. You can practice as much as you like with the stakes you want. It’s a great way to test strategies, gain experience and become confident in your trading.
- Stay Current: Spread betting is a dynamic field, keep abreast of the latest products and trends. Attend lectures (sometimes laid on by spread betting companies for clients) read books, follow experts in the field.
(Spread Betting is also available for sports. If your are interested, then read my blog on sports spread betting).
Financial spread betting offers traders the opportunity to profit from a wide range of markets, including stocks, foreign exchange and commodities. Most companies offer between 10,000 – 20,000 markets to trade on. Markets have their own unique characteristics, so make sure that you know your chosen markets well before placing trades. To be successful you will need to be disciplined, patient and a have willingness to learn. You will of course have set-backs and you will need to come back from those set-backs and learn from them.
If you want to explore further, you could try Spreadex. They are not the biggest firm but they are a secure and solid option. The other advantage is that they are the only firm (or one of the very few) that also offer spread betting on sports.