In this guide to spread betting, we will explain in depth how spread betting works, the terms you’ll come across, the type of financial markets that can be traded, and make you aware of all the costs and risks you need to be aware of when spread betting.
What is spread betting?
Spread betting is trading the financial markets as a bet rather than buying or selling the underlying instrument. Instead of buying or selling a set amount of shares, futures, options or CFDs, you bet an amount based on every point the market moves through a spread betting broker.
As spread betting is trading structured as a bet, there is no capital gains tax on spread betting profits.
What does spread betting mean?
Spread betting is the name given to a kind of trading that enables investors to speculate without having to own the assets. While, conventionally, an investor can profit only if the market increases in value, spread betting enables customers to bet on the market going up or down.
How does spread betting work?
In this video we explain what spread betting is, who it’s for and the main pros and cons of spread betting.
Advantages of spread betting?
The main reason people trade via spread betting instead of investing or CFDs is that there is no capital gains tax with spread betting, so your profits are tax-free.
Other reasons for spread betting include:
- Spread betting offers investors the possibility of making a lot of money (but there is an equal amount of risk).
- Profits made from spread betting are not subject to tax in the United Kingdom (at the moment)
- Investors can gain access to worldwide financial market trading
- Trading can be intellectually challenging and exciting
- Only a small relative amount of money is required if you try spread betting to open your trade
- Spread betting is available 24 hours a day (even some markets on the weekends)
- It is possible to profit even from a falling market, by going short
- Spread betting can help you hedge your longer term growth investments
- It enables a more diverse investment portfolio
- Trading can easily be done from smartphones or tablets on the move thanks to many mobile apps which are available from the top brokers
Let’s look more closely at these many advantages to find out why so many people are attracted to spread betting.
Tax free profits
Perhaps the greatest benefit of spread betting is that all profits are free from tax in the UK, with spread bettors being exempt from stamp duty and capital gains tax. The reason for this is because it is considered to be a derivatives product – investors do not buy a security, instead the bet on what its future price will be. Tax free profits are one of the main differences between spread betting and CFDs.
Why profits being tax-free make a difference?
It is possible to earn an additional 28% or 18% return on any profits. Capital gains tax stands at either 28% or 18% (depending on your tax rate) on your profit if you sell your shares. Not only this, but stamp duty (a tax of 0.5% currently) is usually applied to share purchases in the UK, but spread betting is exempt from this. For both of these reasons, spread betting is a more profitable choice than stock broking, for example, where the underlying security is purchased.
This only of course applies if you make a profit, the downside is that if you lose money spread betting (as around 80% of people do) you cannot offset your spread bet losses against you other capital gains.
Read this amusing story about why spread betting is tax-free for a more sinister look at the tax free benefits.
Leverage and margin
Tax savings are not the only benefit of spread betting. Another advantage is that spread betting is traded on margin or leveraged, and therefore only a small amount of the value of the shares you buy needs to be deposited in order to open a position.
If, for example, you spread bet using a margin or leverage of 10%, the initial deposit on a position on £,5000 worth of shares is £500. As opposed to buying the shares outright with a stockbroker, where £5000 must be paid out to buy £5000 of shares.
This means you need a lot less money up front if you want to spread bet and this opens up wider access to the markets.
So, if you spread bet with a 10% margin, who pays for the remaining 90%? The answer lies with the provider of the spread betting services who, effectively, covers the trader. The size of the margin will differ between different markets and providers, with lower margins generally being offered on more popular markets. You should note, however, that while leverage often is celebrated as a top feature of spread betting, it also magnifies the risk as it becomes possible to lose more money than you used to open your trade. It also means you can diversify your positions, to reduce the single position exposure of your trading portfolio.
Spread betting offers the possibility of short selling, allowing you to make a profit by betting on a fall in the market’s value. You can also hedge your investment portfolio with a spread bet if you think a market of share will go down in the short term.
So, how does short-selling work as a spread bet?
Short selling involves selling the security before buying it again once the price has dropped.
Technically, your broker is lending the shares to you when you are short-selling. your. The shares are lent from either other client position, borrowed from a fund, or (in the case of b-booking) not hedged at all.
If the market falls, you then can buy back the position and your broker will give back the shares to whomever they borrowed from (they pay a fee to borrow them and don’t take the risk on the position). Your profit is any difference in price between the original selling price of the shares and the price at which you bought them back.
For example, if a share currently trades with a value of £73.00 and you have reason to believe those shares will fall soon, you can short sell a thousand shares (£10 per penny) in the company for £73,000.
If you called the market right and a disappointing set of company results in the release causing the price of shares to drop to £72.50 it means you can purchase a thousand shares in the company for £72,500.
Your profit is the difference between the selling price of the share at the beginning of your trade and the price that you paid in buying them back. In this case, £500.
Keep in mind though that theoretically, the price of a share can continuing increasing with no limits. This is different to buying shares outright, where market prices are limited to dropping down to zero and no further. Due to this, you need to implement guaranteed stops or stop losses, on short positions because your losses are potentially unlimited.
You can bet on the market going on. If you think that a share price quoted at £52 is likely to go up and waht to place a spread bet on it, you would be “going long”.
There will be two prices quoted – 5202 is the price to “sell” and 5198 is the price to “buy”.
You make the choice to go long at 5202 for £10 a point (1 point = 1p). That means for each point that the market goes up, you gain £10. You are proved to be correct in your prediction. In this example the price goes up to 5306 and in its sell price to 5302. You want to take your profits and therefore you choose to sell your shares at 5302.
As your bet was £10 for each point, you have made a profit of £10×100=£1000
Spread betting offers trading on literally thousands of different markets. Depending on which provider you choose and the various markets on offer from them, you may be able to speculate on:
- Interest rates
- Foreign Exchange
You can spread bet 24/7 if you choose, even on weekends. This means you can speculate on events that take place out of the market’s standard trading times, when other investors miss out. Oil is one market which offers a clear example of this. Saudi Arabia has considerable influence over the oil market, and any decision which is made out of standard trading hours would result in a sudden fluctuation overnight. Spread betting brokers also offer forex and index trading over weekends.
The spreads are wider because it is harder for brokers to hedge their position, but they still provide a good indication of where a market may open when normal trading hours resume.
Risks Of Spread Betting
With spread betting, it is possible to lose money quickly, and if you have a professional trading account for your losses to exceed your deposit.
Spread betting brokers are obliged by the FCA (who regulates spread betting) to display on their website what percentage of retail trading lose money and that professional traders could potentially lose more money when they spread bet than they put down as a deposit when they opened the trade. This is one primary difference between stockbroking and spread betting.
Take stockbroking, for example. If you purchased shares worth £1000 and then the market crashed so the shares were worthless, all of the money (£1000) would be lost but no more than that. However, in the case of spread betting, if you put down £1000 but the market moved against you, you could not only lose £1000 but if you didn’t have the right risk management in place, you could potentially lose thousands more.
No underlying ownership
As you are placing a bet on a share price rather than owning it you do not get to vote in company AGMs or have any rights on corporate actions. You simply have a bet with your broker. Spread betting platforms will not normally allow spread traders to vote in company issues, but in some circumstances, you position may be reflected in corporate actions.
Spread betting is trading, not investing. As it is riskier than investing in funds, bonds and shares, it is sensible that spread betting is used only as a part of your overall investment strategy so you can lower your trading risks as a whole or speculate with a small percentage of your risk capital.
How to start spread betting
Up to now, we have looked at the risks and benefits of spread betting. Now we’re going to look at how spread betting works and how you can place your first spread bet.
As spread betting allows you to bet on whether a price is going to fall or rise you will be given a quote from your spread betting broker. This comprises a “sell” price and a “buy” price.
As an example, if your provider offers a share 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 way you are going to bet, 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 price movement, with its value depending on the asset 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, the further the market goes in the direction you selected, the more money you will make from the trade. Inversely, the more the market moves against you the more you lose.
However, if the market moves in your favour, you have to overcome the spread – a part of the cost required to open a trade.
Diversification – a basic premise for trading
The best traders in the world only get it right about half the time, most traders admit to being right about 55% of the time. But what makes the right trades right is that there are enough of them to run the wins and cut the losses. Traders need to look at as many trends and momentum charts as possible. A good diversified set of open positions against asset classes such as commodities, fx, indices and stocks should provide a bit of protection against economic indicators and external factors influencing price.
Once the positions (say ten or so) are open you should be able to tell in your open profit and loss section what traders are winning and what trades are loosing. When you call a trend correct run it, when you have called it wrong cut it. The skill is in closing positions, not opening them. A profitable position can go on to generate far more profits than ten small losses.
Risk management – using stops and limits.
As above one of the greatest demises of any trader is not cutting a loss. Traders live in hope that they will eventually be proved right and it is essential that realism is exercised. Traders get it wrong and using stops to automatically cut a bad position takes the emotion out of the game. Set yourself an amount you are prepared to lose on each trade and stick to it.
You can read more on what brokers offer guaranteed stop losses here.
What can you spread bet on?
Depending on which spread betting company you choose, it’s possible to speculate on thousands of different markets such as commodities, forex, shares, bonds, interest rates and indices. Here, we look at what is involved in trading these various markets.
Index spread betting
When people refer to “the markets”, usually it is an index they are referring to. Indices measure the changes observed in a particular selection of stocks which represent a specific market (or part of it). If you trade indices, you can speculate on the overall market’s performance and due to this, usually indices reflect the sentiment of investors about a certain region, sector or economy’s state.
If traders trade indices, they can develop a more diverse portfolio, speculating on either the contraction or growth of a number of industries worldwide. Index trading can also be used for taking a broad view of several companies and can reduce the risks associated with trading separate individual shares.
Some of the most popular indices for trading include:
- The New York Stock Exchange
- The S&P 500 (made up of the USA’s 500 biggest companies)
- The Dow Jones Industrial Average (made up of the USA’s 30 most influenced and largest companies)
- The NASDAQ Composite Index (an exchange focused on technology)
- Nikkei 225
- FTSE 100
Forex spread betting
The Forex global market is the biggest financial market in the world, with up to $4 trillion of trades being placed each day. Forex spread betting refers to trading currency pairs to speculate which will go up in value when compared to the other. Open 24 hours, 5 days per week, the global Forex Market is very liquid and offers potential to achieve huge profits.
How does forex spread betting work?
- Currencies are always traded in pairs. The base currency is the first of the pair and the second is the quote or counter currency.
- Every Forex quote has two parts – the bid and the ask price. The term “bid” refers to the price which the broker will buy the base currency for in return for the chosen counter currency. The term “ask” refers to the price which the broker will sell the chosen base currency for in return for the chosen counter currency.
- The term “spread” refers to the difference between the ask and the bid and this determines the position’s cost to open.
- A major currency pair will be usually quoted to 4 decimal places. A pip or point is the final digit of this quote, so, if you were looking for a quote on EUR/USD and the bid price was 1.0661 and the ask price was 1.0664, there would be a spread of 3 pips. This cost must be redeemed from the traders’ profits and therefore the market must move favourably in order to just break even.
When you trade shares, the price is fixed, however this is not the case when trading currency pairs. Currency quotes will differ between the various brokers and banks. The reason for this is that Forex is an OTC (over the counter) market, with no physical point of central exchange. Therefore, it is not as regulated as the stock market. Since there can be variations in bid-ask spreads between providers, you need to take the time to compare spread betting brokers before you commit to the one which offers you the optimal spreads to suit your trades.
Spread betting on forex enables investors to trade 24 hours a day, 5 days per week as there is no centralized physical exchange to have set closing hours. That means that when you are told the US$ closed at a certain rate, that rate refers to the time at which the New York stock market closed, but spread bettors and traders are still able to trade in Forex after the stock markets close, which is very difficult to trading shares.
You need to be aware of the various terms which are used in this form of trading.
For example, if you trade a currency pair, one currency is long and the other is short. This means if you’re selling 100,000 units (standard lot) of EUR/USD, you are exchanging Euros (EUR) for Dollars (USD). The dollars are “long” and the Euros are “short” in this scenario.
It often helps when you think of some exchanges that you carry out every day. Imagine you have purchased 4 apples for £1 in a supermarket, you are then short £1, but long 4 apples. This principle also works when applied to Forex although there is no physical exchange.
Commodities spread betting
A commodity is a tradable raw material or a primary agricultural product. The commodities which are most commonly traded include precious metals like gold and silver, agricultural products like beef, sugar, coffee, barley, gas and oil.
There are several ways of classifying commodities. A soft commodity is one which is bred or grown (like oats or cattle) while a hard commodity is one which is extracted such as aluminium or copper. Sometimes, commodities are classified in categories of:
- Energy – gasoline, heating oil, natural gas and oil
- Metals – aluminium, platinum, copper, gold and silver
- Agriculture – sugar, wheat, rice, cocoa and coffee
- Livestock and Meat – feeder and live cattle
Usually, commodity trades are carried out via futures contracts on an exchange which standardises the minimum quality and quantity of the communities being traded. As a future is a contract to sell or buy the asset, should the trader fail to close their position before it expires, a large delivery of a commodity that the trader neither wants or needs could end up being the result.
When you’re a spread bettor, however, you won’t need to worry about this eventuality. You are just speculating on the asset’s movement, not actually purchasing the future. Your provider, however, will always ensure that the situation never occurs by closing the trade before it expires.
Typically, the commodity market follows supply & demand, with lower supply leading to a higher price. The price of commodities can be affected by numerous elements including weather patterns, advances in technology, wars, health epidemics and developments in the global economy.
Shares spread betting
A share is a piece of a company ownership which may be purchased and sold via financial stock markets such as the New York or London stock exchanges. The value of shares is determined by supply & demand, and this can be primarily affected by the performance (or the perceived performance) of the company by its investors. If the company, for example, reports to its investors that they have had an especially successful quarter, their share prices usually rise. But if the same company issues profit warnings, or is implicated as being involved in some kind of scandal, it’s likely their share price will fall.
As every share belongs to one specific company instead of being focused on the economic status of a country or whole industry (as is the case if you choose to spread bet on Forex or indices), when you trade shares it’s possible to research in a more focused way about the company which you believe will increase its value.
Spread betting gives traders the ability to speculate on many thousands of different shares across a variety of shares markets around the globe.
Bond spread betting
A bond is an interest or debt bearing instrument which can be traded and represent one way for governments and companies to raise sufficient money so that they are able to pay for their investments.
Should any future change to long term rate of interest be something that interests you, it could be worth trying to speculate on bonds. A lot of investors choose to include bonds in their investment portfolio since they have a reputation for stability and safety when compared to stock market trades. Some investors also choose to trade in bonds as a way of hedging against any pre-existing government bond holdings.
The majority of spread betting brokers will offer a good selection of government bonds from around the globe for investors to try speculating on. Usually, these include all of the main categories of international bonds like 10 Year Treasury Notes, U.S. Treasury Bonds and UK Gilts.
Spread Betting Costs & Fees
Here, we look at the main costs which you will probably encounter once you start trading with a spread betting firm.
Size of the Spread
Traders have to pay the spread cost on every spread bet. If they are to break even, the spread needs to be overcome by market movements in your chosen direction. The spread will be shown in the sell and buy price when you place the trade.
Volatile markets will usually cause the spread to increase, since the underlying security’s price can change rapidly, going up or down in a short period of time. Similarly, if you trade in spread bet futures contracts (quarterly or annual), the further ahead your trade contract is due to expire, the wider its spread can be since the asset’s price has a larger scope to move over a longer time period and providers must necessarily protect themselves from large movements in the market.
Most companies which offer spread betting use their prices to persuade new clients to register for their services, using the most popular markets when advertising their services and on their sites. However, in cases where spreads are smaller, it is possible the overnight charge or margin requirement could be higher. They may also be a minimum limit placed on the capital spend allowed per trade. Check out these numbers before opening an account.
A margin refers to how much capital is required for opening a position. It is defined by a margin rate. The margin rate will depend on which security you choose for spread betting – usually, if the bet is risky, the margin will be higher in order to cover the extra risk.
This is probably the largest cost you are likely to encounter. There are two primary ways of spread betting:
- Entering into a rolling daily contract
- Opening a futures contract
A rolling daily contract may be indefinitely kept open. While they do expire eventually, it will only be after several years. A futures contract, on the other hand, has a set expiry date, although you can close it out before it expires. If you trade using a rolling daily contract, a charge is applied for every night that the trade remains open and this is the “rolling daily rate”. It usually appears as a debit or credit on your account with your provider debiting the amount of you have entered a “buy” or crediting you if you made a “sell” trade.
This cost has been put in place since you are, for all intents and purposes, borrowing your provider’s money since you are trading on leverage.
When it comes to futures trading, there is no rolling daily rate applied, however there is usually a wider spread instead because of the extra costs which the provider has to cover to keep the position open.
When we look at the rolling daily rate, it is composed of the provider’s standard charge as well as a one-month interbank funding rate such as LIBOR.
When a trader doesn’t place a trade or doesn’t maintain a cash position open on their account for more than 12 months, an inactivity is sometimes applied by the broker every month. The amount will differ between brokers, so you should check this out before you open an account.
Glossary Of Spread Betting Terms
Sometimes called “buy price” this refers to the price which the buyer pays for their security. It is quoted within a bid/ask quote.
The term “bear market” means one which is seeing a fall in its value. Traders who think that the price of stock is about to decline can be described with the term “bear” or is described as having a “bearish outlook”. The term “bull market” is the opposite of this.
This refers to the price that the traders is able to sell the security it. Sometimes called a “sell price”.
Difference between bid and ask prices.
Apart from taxation, world governments also borrow money in an international credit market by issuing bonds which are debt-bearing instruments which are able to be traded.
This term described a rising market which is characterized by increases in share prices by more than 20%. Bulls are also traders who think stock market prices are rises. The opposite of “bear.”
Capital Gains Tax
This is a 28% or 18% tax which depends on whether the trader pays income tax at the higher or basic rate. It is paid on any profits on selling shares (which are not in a PEP, ISA or NISA). When spread betting, it’s possible to earn an extra 28% or 18% return on trading profits.
A commodity is a tradable raw material or primary agricultural product. Some of the most popular commodities for trading including precious metals, sugar, coffee, agricultural products like beef, oil and gas.
Daily Rolling Rate
This charge is applied for every day that a trade remains open. This fee generally includes the provider’s standard rate as well as a 1-month Interbank funding rate (such as LIBOR).
Exotic Currency Pairs
An exotic currency pair is made up of a major currency which is paired with another currency from a smaller or emerging economy. Since exotic currencies are sold and purchased in large volumes, the spreads are generally very narrow. Since these emerging and smaller economies have a financial, economic and political environment which changes rapidly, their currencies often make larger and speedier moves allowing the potential for greater profits.
Going Long refers to placing a “buy” bet which you would do if you think the market will rise.
Going Short refers to the occasions when a trader places a “sell” bet as they think the market is going to fall.
Companies and investors use hedging as a way of protecting themselves while reducing their exposure to risks.
When people use the term “markets”, usually they are talking about indices. An index measures the change in several stocks which represent a specific market (or part of one).
During spread betting, traders benefit from using leverage which allows only a small amount of money to be put down as a deposit on the security’s price in order to open trades. This means profits may be hugely amplified.
Liquid markets are when there is a lot of demand from sellers and buyers, resulting in low volatility and narrow spreads. Trades in liquid markets take place easily and quickly and at low cost due to the large amount of ask and bid offers. Low volatility also means changes in supply & demand will have only a minor impact on the prices.
A margin refers to the amount of money required to open positions, defined by a margin rate. This different depending on the security chosen for spread betting. Margin trading enables investors to speculate with just a tiny amount of the amount of money which would normally be required.
This describes a price change in a security. It is the smallest price change possible in the security that is being speculated. E.g. should the FTSE market experience price movements from 6331.95 up to 6331.97, the price change is 2 points.
Usually all major currency pairings are quoted to 4 decimal places, with the final digit being named a pip or point. E.g. if the EUR/USD pair had a quote of 1.0661 as its bid price and 1.0664 as its ask price, the spread is 3 pips.
When the bet approaches expiry, it will be closed then another bet in the same direction and size will be opened to cover the following period to prolong the exposure of the bettor to that security.
Securities are assets which are tradable on the markets. Commonly, the term means any kind of financial trading instrument.
A trader can short or “sell” a market when they think it is going to fall. It is also possible to “sell” if you wish to close out on a pre-existing “buy” bet.
A share is a fraction of the value of a company which is owned by an individual. Shares are traded via stock markets like the New York or London stock exchanges.
The spread is the amount of difference between the sell and buy price of any security. Sometimes called the bid/ask spread, it can be influenced by a number of elements like supply & demand, or the total trading activity or liquidity of that security.
The term “stock exchange” is used to refer to an exchange or market where securities like bonds and shares can be purchased and sold. Prices in the stock market are dependent on supply & demand.
A stop loss orders a security to be sold at a specified price to limit any loss.
This tax (currently standing at 0.5% in the UK) is applied to all share purchases in the UK. Spread betting is exempt from stamp duty, therefore a short or medium term spread bet could well be more affordable than purchasing the securities themselves.
Volatility refers to how much variation there is in a trading price in the market over time.
Spread betting FAQ:
How do you start spread betting?
To start spread betting you will need an account with a spread betting broker, some risk capital, an understanding of the financial markets, and the risk involved in trading on margin.
What currencies can you spread bet on?
You can spread bet on some of the world’s most popular currency pairs for trading include:
The above pairs together with their various combinations represent more than 95% of all speculative Forex trades. However, the major currency pairs are sold and purchased in huge volumes so their volatility is relatively low. This means that, depending on the strategy you choose to trade with, it will usually take longer to make a profit.
Does overnight finance differ between spread betting platforms?
The short answer is yes. Every broker will have slight differences in their policy regarding rolling daily contracts. While some will assign losses or profits each day that the contract rolls over, others only credit or debit the account after the trade has been manually closed.
What is tom-next?
The term “tom-next” refers to “tomorrow next day”. Sometimes, it is called the cost of carry. In the same way as trading futures, a Forex trade could end up with the trader having to accept the delivery of their traded asset should they fail to close out on their contract before it expires. When you trade in Forex, note that the date of delivery is 2 days following the transaction, however the majority of Forex traders are purely speculators who never intend to take delivery of the currency they have chosen.
What is a spread in spread betting?
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.
How are spreads calculated?
There are two key factors that 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 market 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.”
What is day trading with spread betting?
The objective of day trading is very different from investing. Investing refers to a long-term investment in an asset class and should be determined by fundamental analysis and global economic climates. Day trading on the other has nothing to do with a company’s financial standing, its long-term growth prospects and even less to do with what the global economy is doing as a whole.
What is market timing?
This simply means don’t fight the market. The key to picking winning trades when day trading is to go with the flow and piggy back on to momentum and get out when the moment is right.
It is very difficult to automate intra-day trading signals because there are so many variables that are not that relevant in longer-term position taking.
For example, a zig zaggy chart will be difficult to predict the next move, but, a chart with a clear intra-day downtrend may continue to go down. Unless you are a reversion expert (and there are very few) concentrating on finding a trend is a good rule to follow.