What Is Spread Betting? The Beginners Guide
Financial spread betting is a form of investing by means of betting on the movement of global financial markets. Or, in other words, it is trading on markets, rather than trading in markets.
In very general terms, spread betting is making a prediction about the movement of the market either up or down. If the market moves in your favour, in the direction that you predicted, you will make a profit, with your stake multiplied by each point that the market moves in the desired direction. Similarly, if you are wrong, your loss will equal your stake multiplied by the number of points, with which the market has moved against you.
Just like any form of investing, spread betting carries risks and is therefore not suitable for all investors. Nevertheless, it is considered as one of the quickest ways to make a profit on the basis of market movements and for that reason it has become a popular alternative to other more traditional forms of financial trading.
Spread Betting Markets
Spread betting covers a wide range of markets and underlying assets, which is among its main benefits. Investors can bet on the movement of shares, with spread betting brokers usually offering the option of betting on shares of companies such as Vodafone and Apple, which are well-known even to the less experienced trader. Investors can also bet on the movement of indices such as Dow Jones and NASDAQ, as well as on forex currency pairs. Commodities are another popular underlying asset category, and investors can bet on the movement of crude oil, precious metals (gold, silver and so on), or on the market performance of agricultural commodities such as coffee and wheat. Although less popular, financial instruments such as options and futures can also be used as a basis for financial spread betting.Choosing a particular asset over another should depend mostly on the knowledge and experience of the trader, with investors keeping in mind that when betting on a given asset, following any news and developments which might influence the asset price is a must. Tension in the Middle East for instance is likely to have an immediate impact on the price of oil, while news about financial performance of companies will influence the price of shares and the performance of indices.
How Does Spread Betting Work?
As already noted, spread betting is making a prediction or rather a bet, on the price movement of a given underlying asset such as an index or a share. It is very important to understand that in spread betting, you don’t own the underlying asset that you have bet on; what you own is a position for that asset with a spread betting broker.
So, how does spread betting actually work? A spread betting broker quotes two prices for a given underlying asset: a ‘bid’ and an ‘offer’ price. The bid price is the price that you can sell a position at, while the offer price is the price at which you can buy a position. The difference between both prices is referred to as ‘spread’.
If you believe that an underlying asset is going to rise, you place a ‘buy’ bet, whereas you place a ‘sell’ bet if you think that the underlying asset is going to fall. This is known as ‘opening a position’. Positions, which have been opened, must be closed at some point, with the investor either banking a profit or accepting a loss. Although you generally close a position by yourself, it is also possible to set a certain level which will automatically close a position, if the market moves against you.
The movement of the underlying asset is measured in points, as you can place bets of different value against every point of movement, such as £1 per point, £10 per point, etc. So, the profit (or loss, respectively) equals the difference in points between opening and closing your position, multiplied by the value of the bet you have placed per point.
Spread betting examples
Perhaps the best way to grasp how spread betting actually works is by means of discussing several spread betting examples with different underlying assets.
An investor chooses Vodafone shares as an underlying asset, with the broker quoting spreads of 120-120.5. The investor thinks that Vodafone is going to rise and places a buy bet at 120.5 for £10 per point. Later on, Vodafone rises to 125-125.5, at which point the investor decides to close his or her position and makes a profit of £45 (4.5 points x £10). If, however, the investor has bet on the prediction that Vodafone would fall, closing the position will result in a loss of £50 (5 points x £10), since the investor has placed a sell bet at 120.
An investor decides to bet on the movement of NASDAQ, which is offered at 2530-2532 by the broker. The investor is convinced that NASDAQ is going to rise and makes a buy bet at 2532, for £5 a point. Let’s say the index falls and the daily NASDAQ spread with the broker is 2500-2502, at which point the investor decides that it is time to close the position and accept the loss. The loss in question will be calculated as with betting on shares – the point difference, multiplied by the bet value – or in this case, 32 points x £5, resulting in a loss of £160. If our hypothetical investor had instead decided to place a sell bet, his or her profit would have been £140, based on multiplying the point difference of 28 points by the £5 stake.
As noted at the outset, spread betting can also be applied to the price movement of various commodities, such as precious metals, agricultural commodities and so on. So, let us look at the example of betting on the price movement of gold.
The gold quotes offered by your spread betting broker are 1560-1562 and based on your market research you think that the gold price will rise. You decide to risk £20 per point and place a buy bet at 1562. The gold price rises indeed, and the spread quoted by your broker reaches 1575-1577. You sell your position at 1575 and make a profit of £260 – your £20 multiplied by a 13-point movement.
Now, let us imagine that you were wrong in your assumption and the gold price fell to 1550-1552. In this case, if you decide to close your position at 1550 before the price drops any further, your loss will be calculated by multiplying the 12-point difference by your bet, or you will lose £240.
It is obvious that spread betting relies on the same principles, regardless of the underlying asset on which you decide to bet. In consequence, it is very easy for an investor to switch not only between underlying assets from the same category, but also from one asset category to another. The simplicity of transactions and the access to different markets allows investors to easily bet on a variety of assets with the purpose of diversifying their portfolio.