A spread bet is a derivative product that allows Britons to trade on the price changes of financial products without actually owning them. Spread bets differ from normal bets that generally have fixed win-or-lose outcomes. In spread betting, profits and losses are determined by the underlying bet’s accuracy range.
Like all bets, there is also a fixed duration after which profits or losses must eventually be settled. Spread betting is a great way of getting exposure to the opportunities in global financial markets. Betters can go long or short in various trading instruments such as Forex, stocks, cryptocurrencies, commodities, and indices.
Spread Betting Explained
Like all derivative products, spread bets feature bid and ask prices. So, for instance, the price of Barclays Stock will be quoted as 180p/184p. The difference between the bid and ask price (4p in this case) is what is referred to as the spread. This spread constitutes the revenues of companies that offer spread betting contracts. The actual market price of the stock can actually be 182p. With this price quote, buyers will go long at 184p, while sellers will go short at 180p.
The stake amount in a spread bet is variable and depends on the amount of movement that the price of the asset makes. In the above instance, you can choose a stake size of £10 per point. If the price moves up to 190p (6 points from 184p), you will have earned a profit of £60 (£10*6).
By law, all bets must have a timeline. And all spread bets have expiry times too. The popular timelines are daily and quarterly spread bets. Nonetheless, if your price targets are not achieved, you can roll over your bets for another day or quarter. You can also close your bets whenever you like if your profit targets or loss threshold are achieved.
Margin and Leverage in Spread Betting
Leverage is an important feature in spread betting with AvaTrade. It allows investors to gain greater market exposure with a margin amount put forward. For instance, if you wish to buy 1,00000 shares of Barclays Stock trading at 180, you will require £180,000. If you spread bet on the same stock, and the Leverage is 1:10, you will only need to put down 10% of the total investment amount (£18,000) to gain the same type of exposure. The amount you put down is what is referred to as Margin.
Leverage is a powerful tool in investing. In the above scenario, you will gain exposure to the markets as if you invested the full £180,000. So, if the asset price moves according to your prediction by 10%, you will earn profits of £18,000, which is 100% of your initial capital. Still, investors should be careful with Leverage. While it has the potential to amplify your profits, Leverage works both ways and can also magnify your losses on bets that go against you.
Advantages of Spread Betting
Here are some of the benefits of spread betting compared to old-school investing in financial assets:
- Leverage. As mentioned, you can gain greater market exposure with just a small stake. This means there is the potential to earn outsized gains on small capital amounts.
- Go Long or Go Short. Spread betting allows you to trade according to prevailing market conditions. You can go long when you expect the prices of assets to go higher or short when you expect prices to go lower.
- 24-hour Trading. You can trade your favourite financial assets any time you want, regardless of the standard opening hours of the markets.
- Tax Efficient. In the UK and most of Europe, where spread betting is popular, spread betting contracts are classified as standard bets. They, therefore, attract no taxation in the form of Stamp Duty or Capital Gains tax. For investors, this is a tax-efficient way of accessing the global financial markets.
- Multiple Markets. Spread betting allows investors to trade a wide range of markets, such as Forex, stocks, indices, and commodities.
- Low Transaction Charges. The only major cost for any spread bet is the bid/ask spread.
- Flexibility. The innovative spread betting structure allows investors to apply all types of strategies when trading their favourite financial assets online. Some popular strategies include day trading, arbitrage, long-term Trading, news trading, range trading, as well as trend following.
Spread Betting Risks
Like with any form of speculative Trading or investment, risks are always involved. Some of the risks spread betting investors need to be aware of include:
- Leverage Risk. Leverage is a mixed blessing in spread betting because it magnifies profits and losses. There is a chance for spread betters to lose some or all of their capital if prices go against their predictions.
- Market Risk. Financial markets can be very volatile every so often. This volatility can be even more pronounced during important news events such as the release of company earnings reports. High volatility generally increases the risk for investors as it can lead to widening spreads or price slippages in the market.
- Margin Call. A margin call is a notification from your broker that requires you to top up the balance of your account because it cannot sustain your open bets or trades. If you do not respond to the margin call, there is the possibility of having your bets closed out.
- Rollover Risk. Typically, charges are involved if you wish to hold your bets or trade beyond the stipulated duration or overnight. Rollover charges may be negative depending on the type of asset you are trading.
Risk Management in Spread Betting
Spread betting investors generally manage risks by use of stop loss orders. Stop loss orders automatically close out your losing position if a certain set price is achieved in the market. This prevents you from losing more than you had intended in any single trade. For instance, if you are going long on Barclays Stock at 180p, you can set a stop loss at 170p. If the stock’s price starts to fall, your trade automatically closes out when the asset’s price reaches 170p. You will not incur further losses if the price continues to fall below 170p.
Having a spread betting account can help investors access a wide range of global financial assets as well as leveraged Trading in a tax-efficient way. However, investors need to understand the risks involved in spread betting and manage them efficiently.