May 6, 2022
Spread betting is a complicated concept, especially for novices in trading. To understand this derivative strategy and start implementing it, this article addresses all the essentials of spread betting: what it is, how it works, the risks and benefits, and more.
What Is Spread Betting?
Spread betting is a trading strategy that allows investors to speculate on the price movement of various instruments and securities available on financial markets, including stocks, commodities, forex, fixed-income securities, etc.
The investor (or bettor) places a bet on the price movement of a select asset, depending on if they think the price will rise or fall. It’s essential to understand that investors don’t own the asset they bet on; they merely speculate on the price movement based on the prices offered by a broker. This strategy is tax-free and commission-free, which is why it’s so popular with investors.
The Origin of Spread Betting
Spread betting in finance should not be confused with sports spread betting on UK markets. Although these two concepts share the same origin story, today’s use is very different. The first person credited with the creation of spread betting is Charles K. McNeil—a mathematics teacher from Chicago who, during the 1940s, came up with the concept of sports spread betting.
This idea, however, wasn’t used in financial trading until 1974, when a London investment banker, Stuart Wheeler, started his company Investors Gold Index (IG Index). This firm allowed investors to speculate on the prices of gold by using spread betting on the UK gold market at a time when it was difficult to participate in. Today, gold investments are quite popular and can be very profitable.
|DID YOU KNOW? The London Stock Exchange is one of the world’s largest exchanges. But its humble beginnings can be traced back to Jonathan’s Coffee House in 1698, where broker, John Castaing, began offering exchange prices for various currencies, commodities, and stocks.|
How Does Spread Betting Work?
When participating in spread betting, the bettor only needs to make a small deposit—a small percentage of an asset’s current value. Since the value can fluctuate significantly, profits and losses can be substantial, and investors can quickly lose more than their initial investment.
You can either ‘go long’ or ‘go short’ with spread betting. If you place a bet for the product to ‘go long’, you bet on the price to increase over a specific time. Going short is betting that the product’s value will decrease over time.
What Is the ‘Spread’ in Spread Betting?
In financial spread betting, buy and sell prices (bid and ask/offer)—determined by the underlying market price—are quoted by spread betting companies. The difference between these two prices is known as the ‘spread’.
Before investing, it’s crucial to remember that trade costs are factored into the price. So be aware that you always buy higher than the market price and sell below the actual market price.
What Is a Spread Bet Stake?
When engaging in spread betting trading, you need to place a specific amount of money on a select product per unit of movement—known as the ‘stake’ or bet size. The price movements in spread betting are measured in points.
Depending on the volatility and liquidity of the market, a one-point spread can be a pound, a penny, or even one-hundredth of a penny. Both profits and losses are calculated by multiplying the stake by the difference between the opening and closing market prices.
What Is the Margin in Spread Betting?
As previously specified, you must make a small deposit (a fraction of the overall value of a trade, known as the margin) when entering the UK spread betting market. It’s required to open a position on the market. Note the two following margins involved in spread betting.
- Deposit Margin: The initial deposit required to open the position is typically paid as a percentage of the total value of the trade.
- Maintenance Margin: Additional funds must be paid if your position starts to lose money not covered by the deposit. If this occurs, you’ll receive a ‘margin call’ asking you to add the funds or close the position.
Remember that the margin rate on spread betting depends on the market you trade on.
What Is Leverage in Spread Betting?
With the main elements of spread betting explained, you now should understand how leverage works in spread betting. Leverage comes into play when you want to engage in share trading, but buying shares may seem too expensive. With leverage, you can have full market exposure for only a fraction of the shares’ cost; you only need to pay a percentage of the total value of the shares.
|DID YOU KNOW? The forex exchange is the world’s largest financial market, with a daily trading volume of $6.6 trillion. In this market, national currencies are exchanged against one another with such significant players as banks and hedge fund trading.|
|Spread betting is a trading strategy allowing investors to speculate on price movements in financial markets.|
|Placing a spread bet requires a small deposit or a percentage of the total value of the asset.|
|The ‘spread’ is the difference between the buying and selling price.|
|Leverage in spread betting allows for full market exposure for a fraction of the cost.|
|Stop-loss and guaranteed stop-loss orders are risk management tools in spread betting.|
What Is Spread Betting Risk & How Is It Managed?
Spread betting comes with a certain level of risk, depending mainly on the market’s volatility and the margin rate it imposes. So if you place a bet on the asset’s value to rise, but the value plummets in the course of the bet duration, you may face significant losses. You, therefore, need to identify the risks and have a risk management strategy.
The spread betting definition indicates that stop-loss orders are essential tools for managing the risk of spread betting. Note the following two main types of stop-loss orders.
- Standard stop-loss order: This order reduces the risk by automatically stopping a losing trade when the market passes a certain price level. The order will close the trade once it finds the best price when the set ‘stop value’ has been reached. In a highly volatile market, the trade can be closed to a price worse than the ‘stop value’.
- Guaranteed stop-loss order: This order guarantees that the trade will be closed at the exact value you’ve set, regardless of the current market conditions. But guaranteed orders aren’t free and can incur additional broker charges.
When spread betting on shares and similar assets, there’s another strategy for risk mitigation: arbitrage. With arbitrage, the bettor simultaneously places two bets (one long and one short) with two different companies, ensuring that the bettor will win money whichever way the bet goes.
|DID YOU KNOW? 43% of the total foreign-exchange turnover globally is concentrated in the UK. The country also has a trade surplus of £79.3 billion in financial and related professional services.|
Spread Betting Benefits
The spread betting meaning assumes many benefits. Below, we’ve listed the benefits that might entice you to enter the world of spread betting.
For all UK residents, the profits from spread betting are tax-free. Investors who win money with spread betting aren’t obliged to pay capital gains tax on their winnings. It’s important to know, however, that tax laws constantly change. So if you’re not sure if you need to pay spread betting tax in the UK, it’s wise to consult a tax adviser.
No Stamp Duty
Unlike investors who engage in traditional share trading, spread bettors don’t need to pay stamp duty when trading because they’re not buying the financial product they’re trading. The government doesn’t require payment for merely predicting the rise and fall of product prices.
Another alluring benefit of spread betting is that it’s commission-free. Companies specialising in spread betting earn money through the ‘spread’ they offer—so they don’t need to charge additional commission.
Trading on Rising and Falling Markets
It’s worth learning how to spread bet because it allows you to trade on rising and falling markets. Investors can choose to ‘go long’ on products they think will increase in value. But ‘going short’ is just as easy with spread betting, unlike short-selling physical shares.
Wide Range of Markets
If you decide to spread bet, you’ll have many markets to choose from. Forex, global share markets, stock markets, indices, and commodities are all available to spread bettors. (You can also trade stocks through a mobile app.) You also have 24/7 access to most spread betting markets.
Access to Leverage
The question of what is spread betting and trading needs to include the use of leverage, which is a significant benefit for those who can only afford to invest a small sum of money. But even those who have made such small investments stand to make substantial profits thanks to leverage.
Betting in GBP
According to UK traders, one of the best aspects of spread betting is that they can bet with the British pound on all available markets—thereby limiting the currency risk exposure, adding another layer of protection to the assets.
|DID YOU KNOW? Cryptocurrency investments in the UK have become extremely popular. You can also spread bet on cryptocurrencies—more specifically, cryptocurrency pairs.|
What Is the Difference Between Spread Betting and CFD?
The Contract for Difference (CFD) is an agreement between a client and a broker, i.e., a buyer and a seller. This contract stipulates that the buyer must pay the seller the difference between the current value of the financial product and the product’s value at contract time.
With this strategy, investors can turn a profit without buying any assets. The only profit they acquire is due to the price movement of the product in question. In this respect, CFD trading is similar to spread betting. But what is the difference between CFD and spread betting?
The most striking differences between CFD trading and spread betting are shown in the table below.
|No expiration dates||Fixed expiration dates|
|Providers require commission and fees paid upfront||Commission-free|
|Profit is subject to capital gains tax||Tax-free profit|
|Profits are calculated by subtracting the opening position and fees from the net profit||Profits are calculated by multiplying the stake by the difference between the opening and closing prices|
|Available on many global markets||Available only in the UK and Ireland|
With the question of what is spread betting and CFD answered and understanding the differences between the two, you can decide which type of trading appeals to you more.
|DID YOU KNOW? London is the hub of forex exchange. With $3.6 trillion exchanged in forex daily, London has more forex traffic than New York, Singapore, Hong Kong, and Tokyo combined—the four other largest forex trading centres.|
What is spread betting? Hopefully, our guide has helped you understand how spread betting works so that you can implement it in your trading endeavours. Spread betting might seem complicated at first, but once you dive in a little deeper, you can realise that it’s a very appealing and profitable trading strategy.
The term ‘spread’ in spread betting represents the difference between the buy and sell (offer and bid) prices. The spread is always slightly higher than market prices, as trade costs are factored into the spread.