Spread betting, or spread trading, is a popular alternative to trading contracts for difference (CFDs). It is a financial derivative product, which means you never physically own the assets you ‘buy’ or ‘sell’ in the market. Here’s what you need to know.
This article at a glance:
- Spread bets are trades that involve placing a price for each point that an asset moves.
- The narrower the spread, the less an asset has to move in your favor for a spread bet to be profitable.
- Brokers will require you to maintain a sufficient margin for spread betting.
What does spread betting mean?
When placing a spread bet, you commit a price for each point that an asset moves. This is based on the prices provided to you by your broker. If the price moves in your direction, that’s profit in your account balance. If not, however, you make a loss.
For instance, if an asset moves 20 points in your favor, and you commit to a price of 1 USD per point, you will make a profit of 20 USD on your spread bet. Equally, if an asset moves 20 points against the entry price of your bet, you will lose 20 USD on your trade.
You can go both long or short when taking a spread bet. If you believe the market value will rise, you may choose to go long. Similarly, if you believe its value will fall, you may go short.
Spreads vs spread betting
Spreads are the gap between the buy and sell prices of the underlying asset. They refer to the margin a broker takes for you to place a spread bet.
The narrower the spread, the less an asset has to move in your favor for a spread bet to be profitable. For example, say a share of Apple has a spread of one point. As a result, the buy (long) price will sit 0.5 points above its current market value. The sell (short) price will also sit 0.5 points below its current market value.
How does spread betting work?
Before you decide to open a spread bet, you must first decide upon your bet size. The bet size relates to how much money you wish to allocate per point to your trade. This helps you calculate how much money you can make or lose for every point the market moves.
You should also familiarize yourself with the concept of leverage and margin. For instance, it's common for brokers to offer 5:1 leverage on equities. This means you only have to stump up 20% of the full value of your open position, with your chosen broker lending you the remaining 80%.
Although leverage can amplify potential profits, it can also multiply potential losses. That’s why brokers will require you to have sufficient margin within your account. Margin is the deposit you must maintain in your spread betting account to maintain an open leveraged position in the markets.
For example, imagine you were to bet 5 USD per point on the FTSE 100 at a price of 5500, with 10:1 leverage. The outright value of your open position would be 5 USD x 5500 = 27500 USD. In this case, you would need to maintain 10% of the position (2750 USD) as your margin at all times.
Common spread betting strategies
The most popular spread betting strategies for beginners are:
- News-based spread bets
Based on fundamental analysis, spread bettors will look at positive or negative news announcements regarding an asset, and make decisions accordingly.
- Trend-based spread bets
Spread bettors will look to use technical analysis to enter spread bets, based on support and resistance points on an underlying asset. If an asset breaks out through its support or resistance levels, a spread bettor may decide to follow the trend, known as momentum trading.
- Arbitrage spread betting
Although arbitrage opportunities are increasingly rare, spread bettors can find opportunities on illiquid assets. For instance, imagine that one spread betting broker has a bid-ask spread of 100-110 and another offers a bid-ask spread of 90-95. Here, traders could sell (short) the asset with the first broker at 100 and buy the asset with the second broker at 95, securing a five-point arbitrage profit.
Is spread betting safe?
Spread betting is a leveraged product, like contracts for difference (CFDs). Subsequently, it can be easy to make significant losses as it is to make significant profits.
There is also the risk of your spread betting account being closed out during periods of immense volatility. If you don’t have sufficient funds within your account to cover this volatility, your positions will be closed for a loss automatically by your broker.
Nevertheless, adequate risk management measures such as stop-loss and take-profit orders can help you mitigate risk.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorized to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
