Spread Betting Explained – What Is It and How Does It Work?

The medium of spread betting works entirely differently from most other trading styles and has a number of innovative and unique quirks that set it apart from more conventional instruments. It is not so much an investment as a speculation, calling a particular direction in the movement of a market to profit directly from the broker. Simplicity and low capital requirements make it a popular choice amongst traders in the UK and Ireland.

Table of Content

What Is Spread Betting?
How Does Spread Betting Work?
Leverage and Margin
Key Features of Spread Betting
Risk Management
Frequently Asked Questions
Conclusion: Spread Betting Explained

What Is Spread Betting?

Spread betting is the process of trading on markets, rather than trading in markets. A spread trade is essentially nothing more than a bet (hence the terminology of spread ‘betting’), or perhaps more accurately a contract made with a spread betting broker on the future movement of an underlying market as contrasted with today’s prices.

Traders pick a direction of market movement – either up or down, known as ‘buying’ and ‘selling’ – and place a stake per point on the trade. For every 1 point the market rises beyond the buy price in ‘long’ trades (i.e. those trades that predict a rise in the market), the trader earns an additional multiple of their stake. For every 1 point that moves against the trader however, his liability increases by an additional multiple, thus the liability of a particular trade isn’t limited to the amount of the original stake.

This process of adding and subtracting multiples is primarily what attracts traders to spread betting. While spread betting is in practice quite distinct from gambling, the returns that can be afforded by spread betting are easily comparable, thanks to this multiplying effect – known as ‘leverage’.

Leverage is arguably the most central feature of spread betting, and the one highlight that makes it so popular. Because markets can move by a wide range of points over the space of a day, immediate returns can run into the tens of percent, and despite the comparatively massive risk profile, these rewards are still hard to beat elsewhere.

info Spread betting is a derivative product which allows traders of all walks of life to speculate on and profit from rising and falling markets in a cost-efficient way. Since it’s a leveraged product, traders only need a fraction of the capital to take bigger positions and benefit from its tax-free status.

With so many brokers on the market it is important to compare them to find the one which suits your needs.

Spread Betting Brokers and Platforms in the UK

Are you sure spread betting is the right product for you? Check if CFDs are a better option for your trading.

Difference Between CFD and Spread Betting

Spread betting is a low-cost leveraged product allowing traders to benefit from its tax-free regime.

Spread Betting and Tax Regime

How Does Spread Betting Work?

Spread betting brokers take ‘bets’, or more appropriately ‘positions’ in markets with dynamic pricing that responds as the market moves. The following illustration of spread betting pricing explains the basics of how spread betting transactions work.

We will use a FTSE100 spread betting example: The FTSE100 opens at 8,000. Amidst increasingly positive economic indicators and a number of key announcements pending, you conclude that the FTSE will rise on the day, and want to enter into the spread market for it. At the point where the FTSE100 sits at 8000, your broker may quote pricing at 7999-8001. What does this mean?

The prices given reflect the buy and sell prices of the market. As you are looking for a rise in the FTSE, you want to ‘buy’ the market at 8001. This essentially means you are betting that the market will rise beyond 8001, at which point you can start to earn multiples of your stake.

If you believed the market was likely to fall, you would ‘sell’ at 7999. This means you start earning multiples of your stake when the market falls below 7999. The difference in the middle (in this instance 8001 minus 7999 = 2 points) represents the broker’s commission (spread) on the trade. This works because the market has to rise an additional couple of points to yield a profit, thus the broker earns a commission on your successful trade before it starts to earn those elusive multiples for you.

Because pricing is dynamic in response to the underlying movements of the market, it pays to be decisive and get in early. If the FTSE100 in the above example started to rise to 8001, the market would be adjusted accordingly, perhaps to 8000-8002, making it harder for you to squeeze a profit from the market. The sooner you respond, the greater opportunity you will have for making money from the transaction.

Spread Betting Examples

Simplified example (you can benefit from rising and falling markets):

Winning and losing examples:

Winning Trade

The FTSE100 market is quoted as follows: 7999-8001
You can either buy at 8001 (the offer price) or sell at 7999 (the bid price)
You think the price will go higher than 8001 and you bet £1 per point
Your expectation is right and you decide to sell at 8041
You will then pocket £40 (40 * £1 per point)

Losing Trade

The FTSE100 market is quoted as follows: 7999-8001
You can either buy at 8001 (the offer price) or sell at 7999 (the bid price)
You think the price will go lower than 7999 and you bet £2 per point
Your expectation is wrong and you decide to exit at 8019
You will then lose 7999-8019= -20 * £2 = loss of £40

What it looks like in real life:

* It’s recommended to always use stop-loss order especially when you’re just starting out – see full list of orders in spread betting.

Leverage and Margin

Leverage is the degree to which a trader can invest more than he has to cover financially. Often lent by the broker to fund larger transactions, it is inherent in the structure of spread betting, where traders get the advantage of multiplying returns from small gains in the relevant market.

Margin: The portion of a leveraged transaction the trader must be able to cover at any one time. Margin requirements are rolling and may therefore require traders to deposit more funds into their account (if there are not enough funds to cover the trade), otherwise open (and potentially profitable) positions will be liquidated.

Margin call: A demand from the broker for an addition deposit to cover liability, if the trader doesn’t cover the additional liability the broker will close the trade(s).

We used FTSE100 examples, FCA regulated brokers offer 1:20 leverage on indices, meaning that margin requirement is 5% (1 / 20 = 0.05 = 5%).

Learn more about leverage in spread betting.

Key Features of Spread Betting

Key Advantages

Go Long or Go Short – unlike share trading (where you can only gain from rising markets), spread betting gives the ability to profit from rising and falling markets.
Trade on Margin – you only pay a fraction of the full cost of the trade; therefore bets can be placed with relatively small initial outlay.
Tax Free – spread betting is considered to be gambling (even though it’s regulated by the FCA) and thus the gains are tax free in the UK.
No Currency Risk – brokers allow traders to place their bets in the currency of their choice thus eliminating the risk of currency fluctuations.
Wide Range of Markets – trade currencies, indices, shares, commodities, and many more markets on one platform.

Disadvantages

Leverage Risk – you get higher returns on investment but, if not used with caution, can cause considerable losses.
Commission Fee Is Not Transparent – spread betting companies build their commission into spreads, therefore it’s difficult to understand and calculate.
Tax Regime – losses on bets can not be offset against future capital gains.

Managing Risks in Spread Betting

Spread betting is inherently risky, given the nature of the transaction. When a spread betting position moves up by 10 points, the return is 10 times the stake. When a position moves down by 10 points however, the loss is still 10 times the stake – that’s 10 times more than was invested up front. And with financial markets, there’s virtually no limit to the number of points a position can win or lose, which could land you in serious financial trouble.

Analyse Risks: Fortunately, there are ways in which you can counteract the risks of spread betting. Firstly, you need to be aware of the potential risks you’re facing, and you should always work out the numbers before making a particular trade. You might feel comfortable at £10 a point, until you realise that you could rack up a massive debt over a trading hour. Don’t get greedy, and remember that you can win and lose in equal measure.

Use Stop-Loss Orders: It is also possible to position stop-loss orders with the broker which prevent your liability from running away into problem territory. By setting stop-loss orders below the level of comfortable risk for each transaction, you can automatically cut out your losses before they become too significant.

Do your Homework: Another way in which you can personally limit the risks of your spread betting is through understanding the markets you are trading, and by keeping on top of developments affecting both your market and the assets you are trading within it. Bear in mind that you are trading alongside professionals who dedicate their entire working week (and then some) to reading about the markets – if you want to gain even a fraction of their success, it’s crucial that you too put in the legwork to help mitigate your potential losses through better, more consistent trades.

FAQs

How much do I need to start spread betting?

Spread betting doesn’t come with strict rules as to how much you need to deposit to get involved. The barriers to entry are minimal, and it is possible to start trading from as little as 10p a point.

However, given the leveraged nature of the losses you can sustain, it’s important to deposit an amount that leaves breathing space for wayward transactions and allows a diversified trading approach. For a deposit of £500, for example, it is advisable to trade at no more than £1 a point – this can still provide fantastic returns when trades go well, without being too detrimental to your trading position when a single trade goes wrong.

Furthermore, with money to play with you can invest in a variety of different markets to help spread the risk and increase your chances of delivering a profitable outcome overall.

How popular Is spread betting?

Spread betting is extremely popular in the UK, and its trend of growth is one that is continuing at a steady pace. As new traders learn of spread betting as a profitable, tax-efficient trading medium, and the public at large becomes more attuned to the existence of spread betting and the opportunities it presents, the increasing profile of spread betting will only continue to deliver more willing traders, not to mention the increasing number of brokers springing up to satisfy excess demand.

As a tax-efficient, low-cost leveraged way of investing in the markets, spread betting satisfies a need for cheap and efficient trading across professional and individual trader markets.

Is leverage a good thing?

Leverage is a good thing when the markets are moving in your favour, providing much more significant returns than point-for-point trading. Indeed, where leverage is financed by the broker it provides an opportunity to escalate exposure and resulting winnings on a particular trade, and is a virtually essential component for those looking to make their fortunes in trading. However, leverage can also work against you to the same degree.

Is trading with spread betting better than trading CFDs?

Spread betting and CFDs are broadly similar investment products, with both delivering leveraged returns as margined products. However, they also have several key differences, which distinguish the two rather than promote one above the other.

CFDs are the investment vehicle of choice for professional traders because their pricing more accurately reflects the underlying market, rather than the futures market. This allows traders to capitalise on the liquidity factor, which is already built in to the spreads with spread betting.

Spread betting, on the other hand, has the advantage of being tax-free, with minimal exceptions. This can transpire to make spread betting more cost effect than CFD trading, so the answer as to which investment style is better depends more closely on your specific needs as an investor.

Continue reading about the differences between spread betting and CFD.

What can I trade with spread betting?

Spread betting was initially devised and introduced as a vehicle for enabling individuals to invest in gold without physically having to enter the gold market. Today, the choice for spread betting markets has been opened up significantly.

While the range of markets offered varies from broker to broker, every company will offer the following markets:

Indices: major world indices such as the FTSE, DOW JONES, DAX, S&P500, etc.
Stocks: shares in UK and foreign listed companies are widely traded via spread betting including FTSE100, FTSE350 and US30 listed stocks.
Currencies: major world currency pairings, including GBR/USD, EUR/GBR, EUR/USD.
Commodities: both hard and soft commodities are traded, including oil, wheat, corn and, of course, gold.
Interest rates and bonds: interest rates and bonds across the globe.

View full range of markets to spread bet on.

Do I own the rights of an investor when spread betting?

In a word, no. When shares are bought, they come with corresponding rights and responsibilities – the right to vote in corporate decisions such as choosing the board of directors, the right to a dividend (i.e. a share of profits), and the responsibility to keep the company broadly on the right track. These obligations are tied up within the nature of a share – they are fundamental to what a share is and its function, with the ability to speculate on their prices as a definite secondary effect.

With spread betting, you don’t actually acquire any assets, other than a contract with the broker to execute the spread bet. This means there is no CGT or stamp duty payable, but also means that you don’t receive any of the rights of a shareholder. Whether you’re backing a company at 10p a point or £10,000 a point, you will have fewer rights and (responsibilities) than a trader with just one share.

Learn more about dividends in spread betting.

Am I exposed to currency fluctuations with spread betting?

Currency fluctuations can cause considerable problems for traders investing in assets priced in foreign currencies. This can often lead to a situation where gains in an asset’s price are eroded, matched, or even outweighed by movements in the currency markets, thereby hampering profitability.

For example, an investment in General Electric shares on the NYSE might yield a 5% return, but it the USD has risen 6% against the GBP, this actually results in a loss for the trader – in spite of an otherwise successful position.

While share trading and CFD trading open up exposure to currency fluctuations, spread betting is kept immune from the currency markets, because the whole transaction takes place on the basis of the foreign asset, but in your native currency. This means, in the same scenario as above, your 5% rise in General Electric would be translated into many multiple times your stake in GBP, with no exposure to currency values whatsoever.

Do I need to have a trading plan?

Trading without a plan is like driving with no directions – chances are you’re going to get lost along the way. Most people go in to spread betting to make money, but that’s far too wide an objective to base your entire trading strategy upon. Therefore, developing an understanding of trading strategies, and how you can best arrange your portfolio for maximum effect is a crucial step on the road to spread betting success.

Devise a trading plan that encompasses both an approach to research, a trading strategy and a long-term strategy, and you’ll find you are far better placed to make a success from your spread betting than were you to run at it blind.

Find out more about popular spread betting strategies.

Conclusion: Spread Betting Explained

Spread betting might seem easy in concept, it is a notoriously difficult art to master, and one which requires both an intimate understanding of how transactions work, the function of markets and the tools in the arsenal to help traders respond to different situations. While there is no substitute for raw experience, having the knowledge and understanding of your instrument of choice is the first positive step towards becoming a profitable trader with long term prospects.

As distinct from regular trading, spread betting has a number of key benefits, and offers consistent advantages over share dealing in terms of the sheer flexibility and the swift, sharp nature of returns that can be delivered. But it’s wise to remember that while spread betting is popular, it remains a sub-niche of the overall trading industry, and many traders and investors of all sizes are unprepared or simply unable to accept the risks and the downsides it can bring.

Leverage has a key role to play, making transactions both significantly more profitable and significantly more risky, and the burden of leverage is not one to be accepted lightly. In spread betting, unlike other forms of trading, leverage is inevitable and unavoidable, insofar as it is a product of spread betting in its purest form. However, by taking care to ensure you understand the full implications of each transaction, and by identifying and managing the risks of each trade, it is possible to overcome the hurdles of leverage, and to apply it to your advantage.

Markets are the engine of spread betting and all financial trading and provide the basis for placing spread bets. The manner in which they behave and respond to certain changes provides the volatility necessary for spread betting to succeed, and by understanding their inner workings, traders can come a couple of steps closer to realising their potential. Similarly, orders remain the core tools of spread betting traders, implementing their instructions and delivering the flexibility necessary to guard against unwarranted risks and execute automatic trading decisions conditional on market behaviours. By understanding the way in which markets and orders interact, and the specifics of each order type, we can start to build up a picture of how the tools of the trade can be used to protect capital, maximise profits and lower the risk profile on this otherwise highly risky trading style.

Spread betting can be an exciting, fast-moving form of trading, and allows ordinary people from all walks of life to access the markets with very low barriers to entry. That said, the markets take no prisoners, and only by being proactive in your research, planning and strategy efforts can you give yourself the best shot at generating a consistent, aggregate profit from your trading activity.