We cover spread betting from top to bottom.
Complete Guide to Financial Spread Betting
📖 Maybe winning isn’t everything. One just needs to hedge the bet and minimize the risk.Doug Cooper, Outside In.
Spread betting is a derivative approach in which the bettor does not really own the stock or commodity that serves as the basis for the wager. Spread bettors, on the other hand, use the prices provided by their broker to make a wager on whether the asset's price will climb or decrease.
Spread bets, like stock market trading, are stated with a purchase price (bid price) and a sell price (ask price) (ask price). Spread refers to the difference between ask/bid prices. Spread betting, in contrast to conventional securities deals, does not need fees since the broker makes money off of the spread.
If they think the market will go up, investors will side with the bid price, and if they think it will go down, they will side with the ask price. Spread betting's distinguishing features include its leverage (debt), its long/short market access, its many market options, and its favourable tax treatment.
Here is a quick ‘complete’ guide to financial spread betting.
Key Things to Know about Spread Betting
- Spread betting enables traders to wager on the direction of a market without actually holding the underlying securities.
- It’s touted as a tax-free, commission-free activity that enables investors to speculate in both bull and bear markets, yet it remains illegal in the United States, partly due to its use of leverage.
- Using stop loss and take profit orders, spread betting risks may be controlled similarly to stock trading.
Financial spread betting, in its simplest form, is a very adaptable method of trading derivatives. To put it simply, you may use this technique to make a guess as to whether the value of an investment will go up or down.
Nonetheless, spread betting eliminates the need to physically hold the underlying item. Additionally, financial spread betting gains are often excluded from taxation and Stamp Duty. Since investors stand to gain substantially without having any of their earnings subject to taxation, this tactic may appeal to them.
However, if you're not attentive, your money might be at risk since, as indicated before, many retail investor accounts have a negative return. Because of this, you should study the market well before placing any spread bets.
Complete Guide to Financial Spread Betting — Overview
You wouldn't be too far off the mark if you assumed that spread betting was something you'd do at a sports bar. Some have speculated that Charles K. McNeil, a former math teacher who worked as a securities analyst and then a bookmaker in Chicago in the 1940s, is responsible for the notion of spread betting.
About 30 years later, on the other side of the Atlantic, it began as a specialised activity for professionals in the financial sector. Stuart Wheeler, a City of London investment banker, established IG Index in 1974 to facilitate spread betting on gold investments. Spread betting made gold market speculation more accessible for those who otherwise would have had no opportunity to get in on the action.
Spread betting has its origins in the United States but is now outlawed there. However, it’s legal in the UK.
How It Works
Financial spread betting is making wagers in place of real purchases or sales of assets. One common form of conventional trading is the purchase of Company X shares with the intention of holding them until their value rises, at which point they are sold for a profit.
Spread betting allows you to achieve this kind of profit by wagering on whether or not the value of shares in business X will rise. As this value continues to go in the manner you anticipate, your potential earnings will grow accordingly.
That implies you may profit from either a rising or falling market by properly predicting the direction of share prices and placing bets accordingly.
Of course, the reverse is also true; if the underlying market swings against you, your financial loss will increase proportionally.
Entering and Exiting a Bet
When and how do I make a spread bet entry and exit?
Spread bets allow you to put your extra savings to work by simultaneously trading at two different prices. There are two types of prices in each market: the “buy” or “bid” price and the “sell” price. The purchase or sell price may then be used to determine whether long or short positions are desired.
Click “purchase” if you expect the price of your selected asset to increase. If you anticipate a decline in price, use the sell option.
Spread betting is closed by making trades in the opposite direction from the one in which the bet was started. To begin the trade, you must make a purchase; to close the deal, you must sell.
What can I make spread bets on in the financial markets?
Spread betting is a kind of financial betting that lets you speculate on the price movement of a variety of underlying financial instruments. All sorts of financial instruments, such as stocks, currencies, and commodities, might fall under this category.
Because it seems like a straightforward strategy — you're just betting on whether the market will go up or down — it's appealing to many investors. In addition, investors seldom have to pay taxes, such as the Capital Gains Tax, on the money they earn from these types of investments. This might make it simple for you to gain from either rising or falling markets.
Also, spread betting is a leveraged commodity, so keep that in mind. In order to make a transaction, you need to deposit just a little percentage of its worth (as I explained in my earlier tutorial on leverage in trading).
Example 1 — Stock Market Trading vs. Spread Betting
Let's use a real-world example to show the inner workings of this derivative market and the betting process in more detail. First, we will examine a stock market example, followed by an identical spread bet.
Let's suppose a £220.00 acquisition of 1,000 BP (LSE: BO) shares for our stock market transaction. The position is closed once the price increases to £222.00, resulting in a gross profit of £2,000 and a profit of £2 per share on 1,000 shares. Listed below are some essential points.
This deal would have needed a capital investment of £220k without the usage of margin. In addition, charges are often levied to join and leave the stock market. The profit may further be liable to capital gains tax and stamp duties.
Now, let's examine an analogous spread wager. With the bid-offer spread, we'll estimate you can purchase a BP spread bet for £220.00… The next step in placing this spread wager is determining how much to wager per “point”, the variable that measures the price movement. The worth of a point might fluctuate.
In this instance, we will suppose that one point corresponds to a change of one penny in the share price of BP. We will now suppose a £10 per point purchase or “up bet” is placed on BP. BP's share price increases from £220.00 to £222.00, like in the stock market illustration. In this instance, the wager won 200 points, yielding a profit of £2,000 (200 x £10).
While the gross profit of £2,000 is the same in both situations, the spread bet differs in that no fees are typically spent to open or cancel the bet, and neither stamp duty nor capital gains tax is owed. In the United Kingdom and other European nations, spread betting profits are tax-free.
Despite the fact that spread bettors do not pay fees, they may be subject to a bid-offer spread that is far broader than the spread in other markets. Keep in mind that in order to break even on a deal, the bettor must beat the spread. In general, the more popular the traded asset, the narrower the spread, which reduces the entrance cost.
In addition to the elimination of fees and taxes, another important advantage of spread betting is a significantly reduced capital investment. In order to join the stock market deal, a deposit of up to £222,000 may have been necessary.
In spread betting, the needed deposit amount varies, but for the sake of illustration, we will assume a 5% deposit is required. This would need to have a far lesser commitment of £9,650 in order to assume the same level of market exposure as the stock market deal.
The hazard of spread betting is inherent in the use of leverage, which works both ways. If the market swings in your favour, your profits will increase; conversely, as the market goes against you, your losses will increase. While it is possible to earn a substantial amount of money on a very little commitment, it is also possible to lose it just as rapidly.
If the price of BP had dropped in the preceding example, the bettor may have been required to raise the initial deposit or perhaps had the position cancelled automatically. Traders in the stock market have the benefit of being able to wait through a market decline if they continue to think the price will ultimately rise.
Example 2 — Financial Spread Betting
Now let’s look at it based on what direction you bet…
Starting a Long Position
Suppose you hear that shares of Company X are quoted at 350p to 370p. After doing your necessary research, you decide to make a purchase because you think this is undervalued, and the results will be as follows:
- Opening with a purchase, you'll pay £330.00.
- Quoted close of the sale price at £370.00.
- If you paid £10,000 for stock and later sold it for £370, the spread would be £20.
- Which makes a profit of £200 (20 x £10).
Most individuals often use the word “shorting” the market without fully comprehending what it entails.
Going short is making a deal to sell stock without first purchasing any shares. The value of the share is anticipated to decline to a level where it may be sold to you at a loss.
Although shorting the market is not a common practice among individual investors, it is a significant tool for market betters. Compared to placing a “LONG” bet, the potential reward from placing a “SELL” bet on a stock is much higher, but the potential loss is also much higher.
Starting a Short Position
As in the previous illustration, the spread betting firm will provide you with a price for Company X shares in the range of 340-345. In this case, the asking price to sell is 340p and the asking price to purchase at 345p. After concluding that the share price is going to go down, you decide to make a sell transaction, which may go as follows:
- Price at launch: £340.00.
- Closing buy price at £310.00.
- If you sold shares at £340 and subsequently purchased them again at £310, the spread would be £30 (at the same rate of £10 per point).
- 30 x £10 = £300
Ultimately, you'll be able to pocket £300 in pure gains. Not bad!
Risk Management and Arbitrage in Spread Betting
📖 Being able to be repeated controllably is one key element in risk management.Toba Beta, Master of Stupidity (Source).
Spread betting provides useful strategies for limiting losses, despite the inherent risk associated with large leverage.
Standard stop-loss orders
Stop-loss orders limit risk by automatically cancelling a losing transaction when a market crosses a certain price threshold. In the event of a typical stop-loss order, the transaction will be closed at the best available price once the stop value is achieved. Especially when the market is very volatile, it is conceivable for your trade to be closed out at a worse level than the stop trigger.
This kind of stop-loss order assures that your transaction will be closed at the precise price you choose, regardless of the underlying market circumstances. This sort of downside protection is not, however, free. Your broker will charge you an extra fee for stop-loss orders that are guaranteed.
Additionally, risk may be lessened by the use of arbitrage, or simultaneous wagering in two opposite directions…
Arbitrage on Spread Bets (‘Guaranteed’ Wins)
There are arbitrage possibilities when the pricing of similar financial instruments fluctuates across marketplaces or organisations. As a consequence, the financial instrument may be simultaneously purchased at a discount and sold at a premium. Arbitrage transactions capitalise on these market inefficiencies in order to generate risk-free gains.
Due to extensive information availability and improved communication, arbitrage chances in spread betting and other financial products have diminished. However, spread betting arbitrage may still occur when two organisations hold different market positions and create their own spreads.
An arbitrageur wagers on spreads from two distinct corporations at the cost of the market maker. When the top end of one company's spread is below the bottom end of another company's spread, the arbitrageur benefits from the difference. The trader purchases cheap from one firm and sells high from another. Whether the market rises or falls has no bearing on the rate of return.
Numerous forms of arbitrage exist, allowing for the exploitation of disparities in, among other securities, interest rates, currencies, bonds, and stocks. There are hazards involved with arbitrage, including execution, counterparty, and liquidity concerns, despite the fact that arbitrage is often linked with risk-free profits.
The arbitrageur may incur substantial losses if trades are not completed efficiently. Similarly, counterparty and liquidity risks may arise from markets or a company's inability to complete a deal.
Spread Bet Advantages and Drawbacks
Whatever you can do, or dream you can, begin it. Boldness has genius, power and magic in it.Goethe (Source)
Let’s start with the advantages of spread betting.
Spread betting is a kind of leveraged trading that carries the risk of loss but also the reward of possible gain. Some of the most notable gains from adopting this approach are as follows:
✔️ Going in Either Direction
Spread betting's main benefit is that it allows you to profit from both increasing and decreasing prices, or “bullish” and “bearish” markets.
Even more so, if you were short-selling actual shares of stock, you would need to borrow the stock from another investor. Spread betting makes short-selling as simple as purchasing, which is convenient since it may be time-consuming and expensive to do otherwise.
You may save money on commission and other transaction costs by investing this way. This is due to the fact that the spread is how spread betting businesses generate their money off of their investors.
There are no hidden fees or commissions, so you can easily monitor your trading expenses and determine the appropriate spread betting position size.
As I indicated before however, there may be a little fee involved if you want the security of a guaranteed stop-loss order.
Some platforms may need a fee or a commission, so keep that in mind. Before engaging in spread betting, familiarise yourself with these terms. It is also recommended that you only spread bet with a Financial Conduct Authority-licensed broker or firm.
✔️ Potential Tax Savings
Profits from spread betting on trades may be exempt from taxes like Capital Gains Tax and Stamp Duty in nations where doing so is seen as a form of gambling.
However, spread bets aren't always exempt from taxation. If you're thinking about getting into spread betting, it's a good idea to maintain meticulous records and consult a financial advisor just in case you run into any tax surprises.
Always keep in mind that the tax treatment you get may vary depending on the laws and tax regulations of the nation in which you reside or in which your assets are domiciled.
How about the risks associated with spread betting?
Spread betting has several benefits; yet, it also has some potential drawbacks.
❌️ Margin Calls
As indicated before, investors who don't fully grasp the concept of leverage may find themselves in over their heads when spread betting. There may be margin calls as a consequence of this.
When investing, it's best practice to limit your exposure to any one transaction to a small percentage of your total capital and to always know the Sterling pound amount of the wager you want to make. If the stock market turns against you, you may limit your financial losses by using such risk management strategies.
❌️ Broad spreads
Spread betting firms may increase their spreads during times of increased volatility. This has the potential to raise trading expenses and the risk of triggering stop-loss orders. A company's profits and other economic data may have a significant impact on the market, therefore investors should exercise caution when making orders just before the announcement.
CFDs vs. Spread Betting
In what ways are CFDs different from spread betting?
Spread betting and CFDS (contracts for difference) are related financial instruments, and most spread betting sites will enable you to trade in both. Investors may speculate on short-term price swings using these derivative contracts.
In contrast to their name, contracts for difference do not really represent futures contracts but rather enable investors to speculate on the price fluctuations of futures. Contracts for difference also don't have an end date with fixed pricing, and they may be traded just like any other investment.
But spread bets do have an end time that is calculated from the time the bet is placed. Commission and transaction costs are often higher for CFD trading as well.
Nonetheless, there are some parallels to be seen. If you hold a long position in either a spread bet or a CFD, you will be eligible for dividend payments. Spread betting is a kind of derivative trading in which you do not “own” the underlying asset, but instead get dividend payments from your spread betting provider or organisation.
The receipt of dividend payments is an additional source of income for investors and, as such, may be an integral aspect of a successful spread betting or CFD trading strategy.
It's important to remember that any capital gains you realise from trading CFDs are subject to taxation. On the other side, spread betting profits are entirely tax-free. Unlike traditional stock or bond trades, CFD and spread betting transactions do not incur Stamp Duty.
📚 Read my breakdown of the top CFD trading platforms to learn all you need to know about trading CFDs.
To Sum Up
Spread betting has effectively cut entry barriers and developed a huge and diverse alternative market as a result of its continued sophisticated growth since the introduction of electronic marketplaces.
Arbitrage allows investors to capitalise on the price differential between two marketplaces, in particular when two organisations provide different spreads on similar assets.
The allure and dangers of being overleveraged remain a significant issue in spread betting. However, the minimum initial investment required, the availability of risk management tools, and the tax advantages make spread betting an attractive prospect for speculators.
Financial products such as spread betting and contracts for difference (CFDs) may be difficult to understand and may not be appropriate for all investors.
This post is not intended to provide financial advice and should be treated as such. My interpretation of current HMRC regulations serves as the basis for all information.
Your initial investment may not be fully recovered, and the value of your assets (and any income from them) may go down as well as up. It is not possible to predict future results based on how well something has performed in the past. But long-term investment planning takes into account both your risk tolerance and your current financial situation!
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