What is Spread Betting?
The conventional wisdom around trading is that you only profit when a market (such as a share or commodity) rises in value. Spread betting turns this idea on its head.
Spread betting is a financial product that enables you to bet on whether a market rises or falls. So depending how you bet, you can make money when a market either increases or decreases in value. And because it’s a bet, you never actually own what you’re trading.
What’s so attractive about Spread Betting?
For starters it’s tax-free. There’s no capital gains tax or stamp duty. You can profit if you think a market will fall. This is known as shorting.
Choice. Spread betting opens up thousands of markets for you to trade. Depending on what provider you choose you can bet on:
- shares like Google and Apple
- commodities like gold and oil
- foreign exchange (also known as FX or forex) like GBP/USD and EUR/USD
- indices like the FTSE 100 or NASDAQ
- options, binaries and interest rates
You don’t need large sums of cash to get started. For example, £1000 could give you exposure to well over £10,000 worth of shares. This concept is known as leverage and it’s an important one for you to understand.
Who Spread Bets?
You, me, the butcher, the baker and the candlestick maker. Anyone can take advantage of the great benefits that spread betting offers, whether you’re a novice or a seasoned pro.
There are many reasons why people take up spread betting:
- The money (of course)
- The excitement of trading the financial markets
- The intellectual challenge
- To diversify your investment portfolio
- To supplement your retirement pot
- To become a trader and maybe go full-time
- Curiosity about the markets
- To discuss and show off success to friends
Research has also shown that the most successful traders have unifying traits. They are numerate, self-confident and hyper-rational, and typically white collar males aged between 30-40 years old.
What are Spread Betting Risks?
Visit any spread betting provider’s website and you’ll come across the statement ‘losses may exceed your deposits’. But what does this actually mean? And why do they say it? What it means is that the sum of money that you start trading with is not all you could lose. And they say it because it’s a legal requirement for them to do so.
This concept of losing money you don’t have is a key difference between spread betting and say, stockbroking.
For example, in the case of stockbroking, let’s say you bought £1,000 worth of shares. Then unfortunately for you the market totally crashes and your shares lose all their value. You have lost all your money: £1,000. You cannot lose any more than this.
However, with spread betting this isn’t the case. Let’s say you placed £1000 on a spread bet. And the market moves badly against you. Not only could you lose your £1000, but without the proper risk management tools in place, your losses could run into thousands more. How can this happen? Read our section on leverage. But don’t worry! We’ll show you how you can always avoid such a scenario.
And another word of warning, we recommend that you use spread betting as part of an overall investment strategy. If you’re thinking of using spread betting to cover existing loans or debts, or have any history of gambling issues, then hover your mouse cursor in the top right hand corner and shut this window down.
Spread betting is not a magic pill that’ll take your financial woes away.
Taking advantage of Leverage in Spread betting
If this was stockbroking and you wanted to buy £5000 worth of shares, you would have to pay £5000. However, with spread betting you can take advantage of leverage. Leverage means you don’t have to stump up the full amount to place your trade.
For example with leverage, to access £5000 worth of shares you only need to pay a fraction of the cost, in this instance £500. You are getting full exposure to the share for only 10% of the real cost. This 10% is known as margin, the initial cost needed to open up the trade. Who pays the other 90%? That would be the spread betting provider who is effectively covering you. The amount of margin required differs between markets, and the more popular a market is, the lower the margin is likely to be.
If the share price was to rise from £5000 to £6000 you would gain £1000. This would be the same whether it was through stockbroking or spread betting. But the key difference is this – with stockbroking your initial outlay would’ve been £5000, but only £500 with spread betting. Your £500 in spread betting has gone ten times further than if you’d had bought the shares through stockbroking. In effect, leverage has magnified your winnings.
But leverage is a double-edged sword. It can magnify your losses too. Let’s look at an example.
Vodafone is trading at 224p per share and you decide to buy 1000 shares at 5% margin. This means you initial outlay is only £112 (5% x 224p x 1000 shares). If this was stockbroking your outlay would’ve been the full value of the shares at £2240.
Now imagine the worst case scenario and that the shares lose all of their value. If this was stockbroking you would have lost all the money you started with: £2240. However, with spread betting your trade was leveraged. This means you are now liable for the full value of the shares even though your initial outlay was only £112. You would now have to pay the full £2240. This is what catches out a lot of inexperienced traders. The concept that you can lose more than you started with, or as the finance people like to say ‘losses may exceed your deposits’.
‘Yikes!’ I hear you say. ‘Losing over two thousand pounds with just a hundred quid. This spread betting thing sounds like financial base jumping!’ But fear not. There are tools that will automatically parachute you out of a trade when the going gets too rough, meaning your bank account is well protected. The nightmare scenario above was allowed to occur because no risk management tools were in place, which in industry terms is known as ‘being a wally’.
To find out how these risk management tools work, from curtailing your losses to locking in your profits, just check out our section on controlling your risk.
How Spread Betting Works?
With spread betting you are betting whether the price of a market will rise or fall. If you think it will rise you place a ‘buy’ bet. This is also known as going long. If you think it will fall you place a ‘sell’ bet. This is known as going short. The more the market goes in your chosen direction the more money you will make.
Spread Betting – Going Long
You’ve been researching Microsoft. You’ve seen early reviews of its latest operating system and you believe that its share price quoted on the news at 4347.5 will rise as a result. So you go online and place a bet.
The first thing you notice is that Microsoft has two prices, the sell at 4338 and the buy at 4357. Why does it have two prices? Because this is how the spread betting provider makes its money. If you buy at 4357 you are paying slightly over the mid-price of 4347.5. Similarly, if you sell at 4338 you are selling at a lower value that the mid-price of 4347.5.
The difference between the buy and sell price is called the spread and it’s where spread betting gets its name from. Remember that the tighter the spread the better. A wide spread means the market must move further in your intended direction to be profitable.
You decide to buy at £10 per point at 4357 (one point is equal to a penny). This means that for every point the market rises you’ll win £10.
Your prediction proves to be correct. The new Windows operating system is a great success and as the weeks pass, the buy price rises to 4457 and the sell to 4438. You decide the time is right to take your profit so you sell at 4438.
Your profit is calculated by subtracting the current selling price against the original price at which you bought. So 4438 – 4357 = 81.
And because you bet £10 per point, your profit is £10 x 81 = £810
(And just another thing. Spread betting providers charge you for holding a long position. This takes the form of an interest payment typically between 2-3%. If you go short they’ll credit you. These figures were omitted for simplicity’s sake.)
Spread Betting – Going Short
Shorting is a key benefit of spread betting. Unlike stockbroking, it enables you to take advantage of a market if you think the price is headed downhill. Let’s take a look at a commodity – Brent Crude oil
It’s currently trading at 6035 (sell price)/6041 (buy price)
You think the price of oil is going to fall so you place a ‘sell’ bet at 6035 at £5 per point.
A week passes and your diligent research about North Sea oil prices proves to be correct. The price falls to 6015/6021
You close your position by buying at 6021
Your profit is calculated by: 6035 (opening sell price) – 6021 (current buy price) = 18 x £5 = £90
A few things about shorting you need to be aware of:
In theory, without stops your losses could be infinite. This is because there is no limit that a market’s price could rise to. When you go long on a share, the worst it can fall to is zero. However a market’s price can in effect rise without limit.
You need to be aware of the dividend dates. When you go long on a share you can benefit from the dividends (depending on your provider it may or not be already included in the price). But when you short a share you’ll need to pay the provider any dividends that occur.
Spread Betting – When a trade goes against you
No trader gets it right every time; not even Warren Buffet. And unless you have a magic crystal ball, not you either. There’s always risk when you trade the financial markets, and you have to be willing to accept that not every trade will be a winner. Good diligence and research will help mitigate your chances of failure, but no strategy is 100% fool proof.
Let’s look at a scenario where your Microsoft trade didn’t go so well. Microsoft’s sell price is 4338, and the buy price 4357. You decide to buy at £10 per point at 4357
Unfortunately for you, a few days later the news is rife with reports that there’s a security flaw in one of its operating systems. The share price tumbles. The sell price is now 4188 and the buy price is 4207.
You immediately decide to cut your losses by closing your position.
Your loss is calculated by subtracting the current selling price against the original price at which you bought. So 4188 – 4357 = -169
And because you bet £10 per point, your loss is 10 x -169 = – £1690
Your total losses are – £1690
Ouch! And makes it worse is that you only had £500 in your spread betting account. Not only have you lost that, but you now owe the spread betting provider £1190. Money you did not have in the first place. How could this happen? Read our section on leverage. At this point you may be contacted by your spread betting provider (known as a margin call) asking you to add funds or they’ll close you out. That is one phone call you don’t want to receive.
I’m not scaring you am I? The thing is, the above example was entirely preventable. Even if you get things wrong there are trading equivalents of seatbelts that’ll keep you safe. Check out the next section on risk management to find out more.
Spread Betting – Controlling your Risk
Spread betting can be high octane stuff. But there are risk management tools that will catch you if you fall. The below act as risk management tools, to help you when you’re spread betting to avoid losing more than you’re willing to.
A stop acts as a cut-off point for your losses. It represents how much you are prepared to lose before you are automatically closed out of your position. It’s highly recommended, nay imperative, that every trade you make has a stop attached.
Stops have two main benefits:
- You limit your risk when you enter a trade
- You don’t have to be constantly glued to your computer monitoring your position
Let’s take another look at the Microsoft trade. You want to go long at 4357 at £5 per point. And the maximum loss you can tolerate is £200. That means your stop would be calculated at £200/5 per point = 40 points. Therefore you would place your stop 40 points lower at 4317
Should the share price of Microsoft fall beneath this 4317, your position will be automatically closed thereby preventing you from incurring any further losses.
Judging the right level for a stop is a skill. If you set it too far away you could incur heavier losses. However, set it too close and you could see yourself quickly closed out of a trade that was on overall an upward trend. Remember that markets rarely go up in a straight line, they dip and rise so you don’t want to get closed out on a small dip.
Guaranteed stops are like stops, but they’re guaranteed. Confused? Let me explain.
Markets do not fall incrementally ie 4357, 4356, 4355… Instead there can be sharp overnight falls. For example, a market’s price could fall in a chunk from 4357 to 4307. If your stop was at 4317 you would not have been exited at this level. You would have been closed out at the next available price which was 4307. This is known as slippage – the difference in points between your desired price and the price you actually deal on.
Guaranteed stops are not affected by slippage. They’re, well, guaranteed. The catch? You pay an increased spread for this additional insurance.
Trailing stops help minimise your losses and potentially lock in gains. The way they work is as a market moves in your favour your trailing stop moves along with it. The advantage is that if the market moved against you, the trailing stop would lock in more profit than a regular static stop.
For example you buy BP shares at 445. You set your trailing stop at a distance of 20 points. So currently it is at 425.
BP’s price rises to 475. The trailing stop would then also move as well to 455, maintaining the 20 point distance. So if BP fell back to its original value of 445, your trailing stop would close you out at 455, locking your profits in.
With trailing stops you can also set the step level. The step is the increment the market needs to move in your favour before the stop level is adjusted. So if the step was set at 5, the market would need to move 5 points before the trailing stop moved. Steps give you increased control over your trades, especially when dealing with sensitive resistance levels.
Limits act like stops but rather than cut your losses, they lock in your profits. A limit is your target price when you want to get out of a trade while the going’s good. And it means you don’t have to constantly monitor your position.
For example, the FTSE 100 is currently trading at 6912. You think it’s set to rise but it won’t go past the 6950 point. So you go long at £5 per point and set your limit at 6950.
The market rises 38 points to 6950 and your limit automatically closes you out of your position. With your profit at £5 x 38 = £190
Spread Betting Tips
The little things that can make a big difference.
We cannot state enough how important it is to place stops on your trades. They are your safety net. If you don’t use them you are leaving your bank account totally exposed to the unpredictability of the markets. And because your trades are leveraged, any negative turns will be magnified many times over. The only reason you would not place a stop is if you’re Chuck Norris. And you’re not Chuck Norris.
However, you also need to place them sensibly. If you place stops too close to the market value then you run every chance of being stopped out early. A good tip is to always analyse the resistance levels on volatile stocks when deciding where to place your stop.
There’s no need to go in all guns blazing. In the early days of your spread betting career it pays to be conservative. Stick to a few popular markets and get a feel for the price movements first. Then when you get more confident with your strategy and the platform, you can begin to up your trades.
DON’T GET EMOTIONAL
‘So you wanna play rough! Ok. Say hello to my little friend!’ When it comes to spread betting you have to keep your emotions in check. Otherwise things can quickly spiral out of control. For every trade you enter, you should already know your risk reward ratio. And if a trade doesn’t go your way the worst thing you can do is to hang on in there just prove to yourself that you’re right. Don’t pick a fight with a market. It’ll win. Instead, take it on the chin and try to learn from the experience.
The same applies if things go well. Don’t let it inflate your ego because in trading there’s no such thing as a winning streak. If you do you’re in danger of letting your good fortune cloud your judgement.
KNOW YOUR MARKET
Spread betting providers have thousands of markets. However, this does not mean you have to trade on all of them. The best traders place fewer trades and specialise in a few select markets that they know implicitly.
On any given trade you should have a keen interest of the market and the industry it is in. Do you know the macroeconomic announcements that could affect the market? Are you aware of the dividend dates and earning announcements? You should know all of these things when placing your trades.
DON’T BE A SLAVE TO SOFTWARE
You’ve heard stories of people driving into a lake because their sat nav told them to do it. The same goes for trading programs. It’s imperative that you understand the concepts behind the trends and patterns, rather than blindly entrusting yourself to an automated algorithm. They are just tools to help you make the right decision, but any decision should be yours, not a computer’s.