What Is Spread Betting and How Does It Work?

What Is Spread Betting?

Spread betting is one of the easiest types of trading. It allows the trader to speculate without having to own the assets. Spread betting also allows you to profit from market growth and fall.

It differs from CFD trading as CFD involves exchanging the difference in price from open to close. Spread betting involves investing an amount of money per point of price movement.

It is tax-free, cost-effective and does not require the use of a physical broker or market maker.

You make a 'spread' on a live, underlying market price and speculate whether it will rise or fall.

How Does Spread Betting Work?

There are three main features of spread betting:

• The spread – The difference between the offer and bid
• The bet size – The amount you want to bet per unit
• The bet duration – The amount of time before your bet expires

Bets can last for a day or a few months. You can close your bet at any time before its expiry, assuming that it is still open to trading.

The profits are made from correctly guessing which way the market will go – up or down. You don't have to guess the exact amount, just the direction.

For a traded asset, the price quoted shows the difference between the ask and the bid price.

If you are betting a price will increase in value, you buy or go long (bullish) the asset at the ask price.

If you are betting the opposite way, you sell short (bearish) at the lowest quoted price.

Two factors determine the spread width:

1. Volatility – The risk in the market's movements
2. Liquidity – The security volume of daily trading

Essentially, popular assets in volatile markets result in a larger spread.

Spread Betting on a Stock Price Example

You want to go bearish on a Walgreens stock price.

The bid/sell price is 225.98 cents.
The ask/buy price is 227.65 cents.
The spread is 167 cents.
A point is 1 cent, and you bet $10 per point.

You place your spread bet of sell $10 per point of Walgreens.

You then put up your margin deposit, which is what the broker requires.

After two hours of trading, the stock price declines by 0.32 cents.

You choose to close your bet and take the profit – you close at the ask price.

When the bet is closed, the profit and margin are immediately released, ready for you to reinvest or withdraw.

75.3% of retail investor accounts lose money when trading spread bets and CFDs with this provider.

What are the Advantages of Spread Betting?

The advantages of spread betting are:

• Entering or exiting bets is easy – you don't need to be a professional trader
• You don't pay any tax on the money you make
• You have access to a wide range of markets from the comfort of your own home
• There is a host of sophisticated platforms to help you trade
• There are no commission fees and low transaction costs
• Spread betting offers leverages
• You can start with only a small amount of investment
• You profit from loses
• It's a great way to diversify your portfolio

What are the Risks of Spread Betting?

All types of trading and investing come with risk. Spread betting is considered one of the riskiest forms of trading, with no limit to the amount of money you can lose.

Start small and never invest more than you can afford to lose.

Leverage can work against you just as much as it can work for you. Highly leveraged trades always carry the chance of incurring losses that go beyond your initial investment.

Unanticipated economic events such as a change in leadership or the 2020 pandemic cause fluctuations in the market. They cause immediate effects on your bets and can have long-lasting effects. Some economies can take years to recover.

The Non-Farm Payroll (NFP) report is an economic announcement that is known to cause panic on the stock market, mainly forex trading.

Within minutes, the price of currency pairs moves 100 to 200 pips. A $10 pip instantly experiences a profit or loss of $1,000 or more.

Trading gaps occur every day as markets usually close at around 16:30. It is when a security opens much higher or lower than its closing price. Holding bets overnight can increase your risk.

How Do I Start Spread Betting?

There are five steps to spread betting:

1. Open an account with a broker
2. Decide which markets you want to trade
3. Decide if you want to buy or sell
4. Use your chosen trading platform to make your bets and set stop-loss orders
5. Calculate your profit, close bets and reinvest

How to Choose the Right Spread Betting Broker

When choosing a spread betting broker, you want to consider:

• Are they registered, regulated and do they offer a loss protection scheme
• How long have they operated – have they survived previous recessions?
• Are the trading platforms user-friendly and up to date?
• Do they have tools to help with your financial goals?
• What do reviews say?
• What market do they trade?
• Do they offer educational tools and customer service?

75.3% of retail investor accounts lose money when trading spread bets and CFDs with this provider.

What Markets Can I Spread Bet On?

For spread betting, there are no limits on the markets you have access to.

• Stocks are the most common type of investing. While you don't own the stock or receive a dividend, your spread bet provider will adjust your account when needed. Spread betting also allows you to take part in foreign markets.

• Market indices such as the FTSE 100 and S&P 500 allow you to spread bet across an entire market, foreign or domestic. There are also sub-indices such as technology, healthcare, or real estate.

• Commodities such as coal and cotton. They are traded the same as stocks, but their prices are affected differently. Stock prices depend on the economy, while commodities prices depend mostly on the weather

• ETFs have similar advantages to spread betting in that you don't own the physical stock. Spread betting on ETFs allows you the most trading freedom.

• Forex and cryptocurrencies.

• Sports – where you bet on a specific outcome of a sporting event.

What Are the Costs of Spread Betting?

There are no commission fees with spread betting, which is why it is so appealing to many traders. However, just because brokers don't take a commission doesn't mean there are no other fees.

It is often the case that the fee is built into the bid-ask price. In other words, the broker marks up the price in the same way a brand decides its RRP.

Asset values can change second to second, and it is in the broker's best interest to keep those prices up to date.

As an active trader, the spread is your highest cost.

However, there are three other costs that you should take into consideration:

1. Overnight Funding on Rolling Bets

This charge is really two as it is a fee to roll your daily bet and the interest charge to keep the bet overnight.

The overnight interest fee is calculated using a standardized rate such as the LIBOR.

It is calculated as:

Long: percent rolling fee + LIBOR
Short: percent rolling fee – LIBOR

2. Special Order Fees

These are fees placed on guaranteed stop-loss orders.

3. Futures Rollover Cost

Similar to rolling bets, except here you have chosen to take the bet past its expiration into another period.

Depending on the broker you choose, there may be other fees such as:

• Withdrawal costs
• Inactive user charges
• Charges for different types of trading
• Minimum deposit

Things to Consider When Spread Betting

The most important thing to consider when spread betting is to never go beyond your limits.

Yes, high-profit margins are appealing, but you can lose as quickly as you can gain.

Pick your limits and stick to them.

Reduce risk by:

• Knowing the market you are trading in – Commodities trade differently from crypto. Don't just rely on your platform for information. Take the time to learn about all the differences for yourself.

• Familiarizing yourself with economic reports such as GDP, CPI, PPI and Central Bank interest rates announcements.

• Having a trading strategy that you understand and can implement with clear goals.

• Understanding trading terms and values such as 'leverage' and 'margins'.

• Taking advantage of risk management tools such as stop-loss orders, guaranteed stop-loss orders and limit orders.

• Creating a diverse portfolio with different types of trading and markets.

• Taking advantage of the demo accounts available on your trading platform.

Final Thoughts

As with all types of trading, spread betting has its advantages and disadvantages.

The advantages are that costs are often low and it is an easy trading concept.

The disadvantage is that you can lose a lot of money.

Before investing, take the time to learn about trading concepts, trends and markets.

If your chosen platform has a demo account, try it out. You shouldn't jump straight into a trade without seeing the process in action.

Always follow the three day trading rules:

1. Go with the flow and trade when everyone is
2. Diversify your portfolio as much as you can
3. Minimize your risk

There is nothing wrong with playing it safe.

WikiJob does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.