When looking for different ways to trade, you might have come across the term “financial spread betting”. Without enough research, it might seem like a highly complex form of trading that only experts can fully utilize.
But this isn’t the case. The actual concept is pretty straightforward (at least on the surface), and it only needs to be as complex as you want it to be. Adding in leverage, long and short trades, and a range of markets are examples of this.
Before you open your first spread bet position, read through the article below. It explains financial spread betting in simple terms, how margin and leverage play into it, and the pros and cons you should consider.
Key takeaways:
- Financial spread betting is a type of market trading where you speculate on a security’s fluctuation, rather than on the security itself.
- You can take advantage of leverage to make larger trades.
- Spread bet brokers allow you to trade on all kinds of markets.
- There are numerous advantages to this type of trading, including not paying commissions or taxes.
What is financial spread betting?
Financial spread betting is a way to speculate on the price movements of financial markets without actually owning the underlying asset. It allows traders to profit from both rising and falling markets by betting on whether the price of a financial instrument, like stocks, indices, commodities, or currencies, will go up or down.
As such, you importantly don’t own the security you’re speculating on – you’re trading on its price movement. For example, you might place a spread bet position on the price of gold increasing. You wouldn’t actually buy any gold for this but are instead saying you think its price will increase over a set amount of time. If it does, your position pays off and you profit.
It’s worth noting, though, that this process is actually trading rather than “betting” in the traditional sense. This is because, much like stock or forex trading, you’re buying and selling assets to profit rather than putting money on something happening. It might seem like they’re similar concepts, but it’s a distinction worth making.
At the most basic level, this is pretty much all there is to it. It doesn’t really matter what the security is that you’re betting on: it could be forex, commodities, shares, or literally anything else that has a moveable price in a financial market.
How does spread betting work?
Financial spread trading works by speculating on the price movement of various assets and securities whether you think it’s going to increase or decrease in price over a set period. If you’re speculating that it’ll increase, you buy low and then sell when the price is higher. If you’re trading on a decrease, it’s the other way around.
Let’s say the share price of company WAP is currently $103.5, and a spread bet broker is offering a bid and ask price of $100 and $103. You think the share price is going to increase above $103, so you open a $20 trade on every point above the share price moves above $103.
The share price rises to $110 and you decide to cash out with a profit of $140, as the share price has risen 7 points above the ask and you placed $20 on each point.
Of course, if the share price fell below $100, you would lose $20 for every point it drops before you cash out. This is the basic principle of how spread betting works, regardless of what you trade on and how much you decide to trade.
What is a spread, position sizes, and duration?
In the above example, there are a few keywords that you need to know in order to understand financial spread betting. These explanations will help clarify the fundamental aspects:
Spread
The spread is the difference in buy and sell prices for any given security and is the cornerstone of financial spread betting. A spread bet position relies on buy and sell prices, or bids and asks. These are based around the market price, and the difference between the buy and sell prices is the spread. You can use tools like our forex spread calculator to help finding out the actual spread of a financial asset.
For example, the price of a share in a company is $105. The buy price is $103 and the sell price is $108. The spread is therefore $5, meaning there’s a 5-point spread.
Bear in mind that the cost of the trade is built into these prices, so you’ll always have a buy and sell price that’s respectively higher and lower than the market price.
In the screenshot below you can see the difference in the buy and sell price the the bottom left corner:
The bid price is 0.8294 and the ask price is 0.8298 which means that the spread is 4 pips.
Position size
The trade size, or position size, is the amount of money you put on each unit of movement in the market. You can choose your position size provided it meets the minimum requirements of the platform you’re using. Also, you can use leverage for financial spread betting (more on this later).
Movement in the market is measured in points, although the unit a point represents will depend on the security you’re trading. This can be influenced by liquidity and volatility, meaning a single point could be worth a dollar, a cent, a hundredth of a cent, or pretty much anything else.
For example, your position size could be $10 per point in a fairly stable market. Within the duration of your trade, the security moves by 5 points. When you sell, you’d profit by $50, or lose $50 if it doesn’t move in your favor. Try using our spread betting calculator to calculate your profits and losses in seconds.
Trade duration
The trade duration is probably the easiest concept to understand, as it’s pretty self-explanatory. In short, this is the length of time your position remains valid, after which it expires.
The trade duration isn’t fixed depending on the security, and could be a day, a few weeks, or a quarter. Of course, you can cash out your position at any time during the trade duration as long as the spread is still open for trading.
Long and short positions
Two more key terms for financial spread betting are long and short bets. These sound complex, but they’re really not. Going long simply means you’re betting on the security increasing in value over the designated period. Going short is the opposite.
There’s no need to really give an example of this, as it’s the same as any other spread trading example. Long and short betting are the technical terms for speculating on the increase or decrease in the security’s value.
How leverage and margin play a big role
Leverage in financial spread betting works in exactly the same way as any other securities trading. It refers to utilizing a trading platform’s ability to essentially sub you the money for the size of the trade you want to make.
For example, if a platform offers 1:50 leverage, you could invest $100 to place a spread position of $5,000.
Similarly, margin refers to the deposit you put down to open your spread trade or the money you may need to put into your trade to maintain your position. These are the deposit margin and maintenance margin respectively.
Trading on spreads (particularly volatile ones) can trigger stop-loss orders and margin calls more quickly, although the risk of a margin call is related to how much leverage you’ve used on each specific trade.
Both of these impact the amount of money you stand to make on a spread bet, so it’s worth considering the timing of a spread bet position you plan to make on a potentially volatile market.
What are man risks?
As with all types of trading, spread betting comes with risks, particularly with leveraged trading. These include:
Market volatility
Financial spread betting can be conducted on particularly volatile markets, which obviously comes with a high level of risk. If you’re betting money on the movement of a volatile security, there’s a higher chance of you losing money because of the sheer fluctuation.
Amplified losses
Leveraged trading effectively means betting with money you don’t own. While this gives you potential to amplify your profits to an extent you otherwise wouldn’t be able to access, the same is true for your losses. By using our stop loss calculator you can minimize your potential losses by limiting the downfall.
Wide spreads
A wide spread is used when a market has entered a period of volatility. A wide spread increases trade costs because of less favorable market conditions. Lower liquidity and higher volatility make it harder for brokers to facilitate trades, and the higher costs compensate them for the greater risk of someone taking your buy or sell trade.
The pros and cons
Spread betting can come with many advantages, but there are also disadvantages. The most important ones are listed here:
Pros
Ease of access
One of the biggest advantages of spread betting is the accessibility it offers. You’re able to trade on increasing and decreasing securities prices rather than buying the security itself.
Along with potentially being more accessible from a cost perspective, it’s also easier to take advantage of a short-sell position. For example, rather than borrowing the stock you want to short sell, you simply speculate on the process of the stock itself decreasing.
Zero commissions
Unlike forex, crypto, futures trading, and so on, spread betting is commission-free in a traditional sense. The cost of the trading firm’s services is included in the spread itself, meaning you shouldn’t have to pay further commissions on top.
Tax and stamp duty-free
Another important advantage is that this form of trading is tax-free. This is because any profits you make are exempt from capital gains taxes, which isn’t the case with traditional investment forms. Also, in the UK, you don’t need to pay stamp duty on your profits because you never actually own the asset you’re trading on.
No need to be a market guru
Technically speaking, spread trades don’t really need the same kind of acute market knowledge that you might need for trading on more niche securities. All you really need to know is whether you think the security is going to increase or decrease in price.
This doesn’t mean you should go in blind, of course. It’s always worth backing your position with some kind of research. The benefit, though, is that you don’t have to be an expert in crypto or futures to trade on their market position.
Cons
Outsized losses
Perhaps the main disadvantage is that your losses aren’t limited to your original trade size. The impact of leverage can make you lose hundreds of times your original position size, and betting on the point difference of a security doesn’t carry any kind of hard limit. This can easily be avoided by using a spread betting broker that offers negative balance protection.
No control or ownership over the assets
This won’t be a downside for everyone, but it’s worth noting. Financial spread betting can be seen as a third-party position in the market because you’re not actually buying or owning the security.
As such, you have no voting, ownership, or control rights that could be utilized in the security’s market value. In essence, you’re little more than an observer, which can either be a big advantage or a notable disadvantage.
What markets are available?
The short answer is that there isn’t really a limit on available markets for trading spread bets. If the security or market has a financial position that fluctuates, it’s likely you can spread bet on it.
IG, for example, offers spread trading on more than 17,000 markets. These include forex, crypto, indices, commodities, shares, and pretty much anything else you might want.
Conclusion
So, is financial spread betting for you? It can be an interesting way to get into securities trading because it can expose you to various markets without prior knowledge. Similarly, it’s a fairly accessible option because long and short positions are easy to obtain without investing in the security itself.
Of course, no type of trading is without risk. Make sure you’re aware of what leveraged trading involves, how margins work, and the nuances of long and short positions before you try spread betting.
