There are two types of spread betting firms. The good and the bad. The good spread betting brokers treat their customers as clients and aim to forge long-term relationships by providing excellent customer service and trading tools. The cost of trading may be slightly higher as most of the client trades are hedged in the underlying market.
Then there are the bad churn and burn spread betting brokers, who only want their customers to open an account, deposit funds, start trading and lose money. Most of these trades are not hedged and the broker is acting more like a bookie taking your bets rather than a broker proving access to the financial markets.
When we looked at which spread betting brokers to recommend we only like brokers that earn money from spread and financing charges, not from clients losing money. However, in reality, most brokers in an effort to reduce their own transaction costs use a combination of both.
Obviously, there are bad spread betting brokers who are evil and only want you to lose all your money but we don’t work with such horrible people.
Tight spreads around market prices
Spread betting brokers earn money from the spread around market prices. If for example the price of Vodafone shares is 195.1 bid and 195.2 offered the broker would quote 195 bid and 195.3 offered. As there is no commission on spread betting trades, commission is replaced by the slight differential in the price.
It makes trading admin free and provides traders with a good clean price for their trade blotters for working out daily P&L. So if you make money spread betting you are likely to trade more. The more you trade and the bigger you trade the more a spread betting company earns from the spreads around your traded prices.
The spreads usually work out to whatever the industry standard commission is on the market you are trading. For FTSE 100 stocks is could be around 10 basis points. For spread betting on AIM stocks is may be in the range of 50 basis points or higher depending on liquidity.
Daily financing charges
Spread betting brokers want their customers to be active traders for a long time and customers that make money by holding long-term positions are a great source of income for them. A second revenue stream for spread betting brokers is called finance charging. When you spread bet you are doing it on margin, usually from about 5%. So you can buy £1,000 worth of stock with only £50 on account. This is assuming that your maximum liability on the trade is a £50 loss.
You’ll either need to put a stop loss in or get margin called and cut out if your loss gets bigger. So if the spread betting broker has hedged the position, they will have lodged £1,000 at the London Stock Exchange. This means the broker is lending you £1,000 and for that, there is an interest charge.
Interest charges are usually around 3% around the one month LIBOR rates. As they are low at the moment, it is relatively cheap to hold positions overnight. So if you as a customer were to have a profitable position that you kept open for a year worth £1,000 the broker would earn 3% over a year from it.
They will apply this charge to your account in the form of a daily rolling spread if it is a daily bet, or by marking up the price if it is a quarterly bet. If you are short and the spread betting brokers interest rate allows you can actually receive money because you are in theory lending the spread betting broker money.
But in practice, as rates are so low they inverse and you’ll probably be charged. So the more money you make spread betting and the longer you hold your positions open the more the spread betting company makes. It’s in their interest to keep their customers happy, profitable and trading as much as possible.