What is Financial Spread Betting? (And How to Make Money from It)
March 26, 2019
Spread betting is a speculative activity that involves making a bet on whether the price of a financial instrument will rise or fall. There are two prices quoted for a spread bet, the bid and the offer price.
A trader who speculates on rising prices would buy (or go long) at the offer price, while a trader who speculates on falling prices would sell (or go short) at the bid price. The difference between the bid and offer price is called the spread and represents the profit of the spread betting broker.
Watch: What is a Spread Bet?
It’s important to note that traders who spread bet don’t actually own the underlying security. They’re simply speculating on whether the price of the instrument will go up or down. However, the fact that the underlying instrument is now owned leads to some interesting advantages of spread betting, which will be discussed further below.
There are three important elements of any spread bet: the bet size, the spread, and the bet duration.
- Bet Size – The bet size is the amount that a trader bets per a single price-tick or point. For example, if your bet size is $5 per point, and the price of a security jumps from $52.10 to $52.50 (40 points), you would make a profit or loss of $200 in that trade, depending on whether you were long or short.
- Spread – The spread is the difference between the bid and the offer price. When spread betting, a trader will always buy at a price slightly higher than the market price and sell at a price slightly lower than the market price.
- Spread Duration – Finally, the spread duration represents the length of time your position remains open. Most spread bets are so-called daily funded bets which remain open until you manually close them. Daily funded bets have a default expiration date set some way off in the future, but most traders decide to close their positions once they’re satisfied with the unrealized profits of their spread bet.
How to Make a Profit from Spread Betting?
In spread betting, the most important decision you need to make is whether to bet on falling or rising prices of a financial instrument. Your profit or loss will largely depend on that decision and on the bet size of your spread bet.
Traders use various tools to analyze whether the price will go up or down in the future. Some of the most popular way to analyze the market is technical analysis, which uses past price-action in an attempt to predict future prices.
Technical traders believe that all publicly-available information is already included and reflected by the price, meaning there is no need to follow news or any other data besides the bare price-chart. Popular technical tools in spread betting include chart patterns, channels, trendlines, oscillators and trend-following indicators.
Other traders believe in the power of market fundamentals. These fundamental traders follow fundamental factors that could influence the price of a security, such as earnings reports and rumors on new products for stocks, or labor market statistics and inflation reports for currencies, to name a few.
Whether you decide to go with technicals, fundamentals or a combination of the two, don’t forget to back-test your trading strategy on a demo account and to keep a trading journal to identify where your strategy could be improved.
Spread Betting Example
Let’s say the stock of company ABC is currently trading at a bid price of $150.50 and an offer price of $151.00, having a spread of $0.50 or 50 points. Your analysis shows that the price has upside potential, both from a technical and fundamental standpoint. In this situation, you decide to open a spread bet on that stock and bet that the price will rise in the future, placing a bet size of $3 per point. You’re going long at the offer price of $151.00.
After a few days, the price of the stock reaches $153.00/$153.50 (bid/offer), making you a profit of $600 (200 points x $3 per point). Note that when closing your buy position, you’re dealing with the bid price of $153.00.
Pros and Cons of Spread Betting
Just like other speculative products, spread betting has certain advantages and disadvantages that traders who are involved in this type of speculative activity need to know about. Spread betting carries a high risk of capital loss, especially in times of increased market volatility.
During these times, traders can also experience wider spreads and slippage, which can eat into their profits and increase their losses. On the other side, notable advantages include the ability of short-selling, relatively low trading costs during normal market environments and tax benefits.
- Short-Selling – Since traders don’t own the underlying financial security of a spread bet, they can bet on both rising and falling prices. In other words, traders can make a profit even during bear markets. When short-selling, traders borrow the underlying security and sell them at the current market price. After the price falls, traders buy the same securities at the lower price and return the borrowed amount, making a profit on the difference between the selling and the buying price. This entire process is fully automated.
- Low Trading Costs – Spread betting offers a cost-effective way to trade on financial markets. With most spread betting companies, the only cost you’ll incur is the spread, i.e. the difference between the bid and the offer price.
- Tax Benefits – In certain jurisdictions such as the United Kingdom, spread betting is considered as an online gambling activity is therefore not taxed.
- Volatile Markets – Even though traders live on market volatility, inexperienced traders may easily lose their entire trading account in times of sharp price movements. If you’re a complete beginner in trading, try to avoid having open trades in times of high-impact news releases.
- Margin Calls – Trading on leverage offers traders to have a much larger market exposure than their initial trading account size would otherwise allow.
- Spread Widening and Slippage – During times of lower market liquidity or high-impact news releases, trading costs can significantly increase as a result of spread widening. Similarly, if a trader tries to open a new position in those times, there can be a large difference between the price that the trader sees on the trading platform and the actual price at which the market order gets executed. This difference between the observed price and the execution price is called slippage.
Financial spread betting is a speculative activity in which traders don’t own the underlying security. When spread betting, traders bet on whether the price of the underlying security will rise or fall in the future. If the trader thinks that the price will go up, he or she will be quoted the offer price.
Similarly, if the trader thinks that the price will go down, he or she will deal with the bid price. The difference between the bid and offer price represents the spread, which is the trading cost of the trade.
Spread betting offers a cost-effective way to participate in the world’s financial markets. Not only can traders bet on rising prices, but also on falling prices due to the ability to “short-sell” a financial instrument.
Leverage offered by spread betting companies allows traders to open a much larger position than their trading account size, which magnifies both the profits and losses of their trades. Finally, since spread betting is considered as an online betting activity, UK traders can withdraw their profits without any tax obligation.