Put simply, financial spread betting allows you to speculate on rises and falls in the financial markets. You can profit, or incur losses, for each point change matching the direction that you predict the markets will move in.
Financial spread betting offers a number of benefits that traditional trading can't provide, like not having to own the underlying asset you're trading (e.g. a share in Apple). You can place financial spread bets on thousands of global shares, indices, bonds and securities without ever having to deal directly with the markets.
What is spread?
As a trader on any derivatives market you are offered two prices either side of the underlying market price: the buy price and the sell price. The difference between these two prices is known as the spread.
For example, the underlying market price for the UK100 index is at 6500 points. Currently the bid price for this market is 6499.6 and the offer price is 6500.4. The difference between the bid and offer (6500.4 – 6499.6 = 0.8) is known as the spread.
The size of a spread is important because it is essentially the amount you are charged for every trade you make. The tighter a spread is reflects how quickly you can start to realise profits, or losses, from the market you are trading.
How does financial spread betting work?
A financial spread bet comes down to you predicting whether the market you are trading will rise or fall. If you are going long in the belief a market will rise, your bet will open at the offer price. Your profits will increase with each point rise above the level you entered the trade.
If you believe the markets will fall and choose to go short, your bet will open at the bid price. Assuming the markets behave as you predicted, your profits will increase with each point the market falls below the price you entered the trade.
For example, you speculate the UK100 will rise and go long (open a buy position) with a stake of £10 at 6500.4. As you predicted, the UK100 rises 10 points to a bid-offer of 6509.6-6510.4. At this point you decide to close your position and sell at the bid price of 9509.6.
Because you bought at 6500.4, you have increased your position by 9.2 points. 9.2 points multiplied by your stake of £10 gives you a tax-free profit of £92.
Conversely, the markets move against you and fall 10 points to a bid-offer spread of 6489.6-6490.4. You opt to exit your trade and sell at the bid price of 6489.6.
You bought at 6500.4 and sold at 6489.6, which means the difference between your opening and closing positions is 10.8 points. 10.8 points multiplied by your stake of £10 incurs losses of £108.
What happened to my profit?
The market moved by 10 points. Why isn't it £100 profit or £100 loss? The difference between the £92 and £100 is the cost of the spread. £10 a point multiplied by the spread of 0.8 is a spread cost of £8. In the losing trade you also pay the spread cost of £8.
Spread is how the broker makes its money from a trade.
That cost also depends on whether the spreads are fixed or variable…
Fixed Spreads vs Variable Spreads
Many spread betting providers offer variable spreads, some offer fixed spreads but why is it important?
When offering variable spreads brokers can move spreads, normally in reaction to the underlying market. Spreads typically 'blow out' when liquidity is scarce and uncertainty high: a good example is the Swiss Franc unpegging from the Euro in January 2015.
If the spread is variable and is widened before the closing leg of a trade is made, then the cost to exit the trade just increased. Traders have to eventually exit a trade so there is little they can do with the cost of the closing leg should spread widen.
A fixed spread doesn't change for the period it is specified for (i.e. during market hours), whatever happens to underlying market conditions. That means a trader will know the cost of exit before entering the trade.
To offer some balance, a fixed spread gives a trader certainty but on the opposite side of the trade is the broker or provider who, because it's zero sum has increased uncertainty, and this is likely to reflect in a wider spread. This is why we think it's important to combine a fixed spread with a tight spread, so you are getting that certainty while ensuring it is not costing you too much.
What are the benefits of financial spread betting?
Tax-free: Any profits you make from spread betting are exempt from UK Capital Gains Tax and UK Stamp Duty. This may be dependent on personal circumstances and tax laws may change.
Leveraged: One of the key benefits of a financial spread bet over traditional trading is that it is a leveraged product. This means that you only have to deposit a percentage, or margin, of the total notional value of your bet. This margin requirement is typically between 0.5% and 4% of the potential value of your trade. Leverage can also work against you if the trade does not work out as expected so you need to understand this risk carefully.
Go long or go short: By taking a sell position, you can profit from a fall in the value of a market. Unlike traditional trading, you can always stand to profit no matter which way the markets are moving.
Spread bets are leveraged products. Losses may exceed deposits.
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