Up to now, we have looked at the risks and benefits of trying spread betting platforms. Now we’re going to look at how it works and how you can begin to place your first trade.
Just as a recap, spread betting is a speculation on whether a security’s price is going to fall or rise. Once you’ve chosen which security you want to spread bet on, you will be given a quote from your provider. This comprises a “sell” price and a “buy” price.
As an example, if your provider offers shares in Vodafone at a price of 205/206, the left value is its sell price and the right value is its buy price. Should you believe the market will rise, you “go long” or bet on “buy”. On the other hand, if you believe the market is going to fall, you “go short”, or place a bet on “sell”.
After deciding which position you are going to take on your chosen market, you then need to choose how much you are going to commit to the trade per point of movement in the market. A pip, or point, is the measurement of the security’s price movement, with its value depending on the security type. In the case of equities, for example, one point tends to equate to 1p, however with indices, usually 1 point equals one point in the index value.
After placing the bet, you simply watch the markets to see whether they will go up or down. The further it goes in the direction you selected, the more money you will make from the trade.
However, if your trade is going to make a profit, you have to overcome the security’s spread – a part of the cost required to open a trade. Find out more…
What Is A Spread?
The spread refers to the difference which exists between a security’s buy price and sell price. Typically, most providers will add a margin over the usual sell and buy market prices to create the spread. E.g. a share which is price to sell at 100p and to buy at 102p on the market may well sell at 98p and buy at 104p via your provider.
If you are going to make a profit when spread betting, you have to overcome your spread’s cost before you break even. If, for example, your provider offered Vodafone shares with a 204/206 spread and you went long, with a bet of £10 for every market movement point, you would need to wait until the selling price had increased by 3 points up to 207 so you could make a profit of £10, or increased by 2 points so you could break even.
Which Factors Determine Spread Width?
There are two key factors which affect a spread’s size – volatility and liquidity.
- Liquidity – this term is referring to the security’s volume of trading every day. E.g. some securities trade constantly, however others only trade a couple of times daily. Securities which trade in big quantities and frequently will usually have a narrow bid-ask spread. This is because when securities have low trading volumes, the fewer traders they attract. This, in turn, means that brokers struggle to find buyers or sellers for it and therefore they require a larger amount of compensation to handle the transaction resulting in a quote for a bigger spread.
- Volatility – this refers to the risk or uncertainty in the market’s movement size and refers to times of dramatic falls or rises in the markets. If the market is volatile, e.g. when sensitive economic data is revealed, spread often widen as participants are reluctant to enter trades while the price is shifting rapidly.
Therefore, if the security is popular and the market is volatile, the spread will be tighter.
“Wide spreads mean the market has to go further in your chosen direction for the trader to make a profit and therefore a narrow spread is best.”
Also in our ultimate guide to spread betting, it covers:
- Ten Good Reasons To Try Spread Betting
- The Potential Risks
- Positive Thinking – Going Long
- Going Short – Winning A Trade From A Falling Market
- 5 Ways To Make A Profit From The Market
- Spread Betting’s Hidden Costs
- Choosing The Right Provider Of Spread Betting Services
- Glossary Of Spread Betting Terms
- Compare spread betting brokers, features, accounts and markets