How does Financial Spread Betting Work
Spread betting is among a number of derivative trading strategies that have been around for many decades. This article will explain what spread betting is in trading, in particular, because spread betting also exists in sports.
You'll also learn the types of spread betting, how it works, what risks it carries, and which brokers you can go for, should you decide it's the right choice for you.
Do you want to start trading Forex? Open an account on Roboforex!Spread Betting Definition
Spread betting is a type of derivative trading strategy where the participant does not own the asset but only bet on the asset's price. The betting is based on the spread of the asset in question, which can be a stock or commodity.
What does spread mean in betting? Just like traditional stock trades, there's a bid price and an ask price. The difference between these two is called the spread.
In simpler terms, spread betting allows individuals to bet on price increase or decrease of an asset with a spread betting broker.
The history of spread betting goes all the way back to the 40s. However, it only became a proper form of trading, albeit derivative, in the 70s when Stuart Wheeler founded IG Index in London.
Main Types of Spread Betting
Spread betting can categorically be divided into two main types: financial spread betting and sports spread betting.
Financial Spread Betting
Financial spread betting is the most prominent, at least in the UK. Financial spread betting follows financial markets like the stock market or commodities market.
Spread betting on stocks or commodities is provided by spread betting brokers, who make money from the spreads and do not charge any commission. This is unlike traditional stock trading, where the broker charges a commission.
Depending on the spread betting broker, you may be able to bet on the spread of different stocks or commodities traded on major or local exchanges.
Sports Spread Betting
Sports spread betting is not much different from financial spread betting. However, it offers an alternative to fixed-odds betting, where the wager knows the possible returns or losses beforehand. The odds are regarding the outcomes of a sports match.
With spread betting, the betting is done on the spread, which is a range of outcomes predicted by the sports spread betting company—for instance, the length difference between first place and second place horses in a horse race.
Sports spread betting is particularly popular in the UK, where it's even regulated by the Financial Conduct Authority (FCA).
Pros and Cons
Spread betting is essentially like gambling, so it has its pros and cons.
👍 Pros
• The main advantage of spread betting is that there are no commissions whatsoever. So the profit you walk away with is all yours. On top of it, there's little or no spread betting tax depending on where you live because spread betting earnings are treated as winnings, not capital gains.
• Another pro is that investors can go short and long in spread betting, meaning they can bet on price increases and price drops. In comparison, short selling stocks is a laborious and time-consuming process.
• This is also an advantage that you don't have to buy or sell the actual asset, for example, a stock, but you can make profits just by speculating price changes.
👎 Cons
• The major concern with spread betting is regarding leverage, which makes it a high-risk strategy. If an investor takes on a big position, they risk margin calls.
• Furthermore, sometimes the spreads are wide, especially in times of volatility. This kind of investment is even riskier because trading costs can get high.
How Does Spread Betting Work?
The spread betting market follows major financial markets, including stocks, commodities, indices, and forex. Investors can place bets with a spread betting broker.
But how does it exactly work? Here's an example to help you understand:
An investor joins a spread betting platform where the spread-betting company is placing a bid/ask price of an XYZ stock at £100/£103, whilst the stock price is £101.50. The investor believes that the market will go down, i.e., the stock price will fall, so they bet at bid to sell the stock for £100.
Now, this works is that the investor must bet an amount for every point the stock may fall below £100. Keep in mind that points values can vary. For this example, let's assume it's £1.
If the price of the stock falls to £85/£88 as the bid/ask price, the investor makes a profit. How much profit do they make? That depends on the points and the money they bet on it. If they bet £10 on each point, they made £120 profit based on this calculation [ (£100 - £88) x £10 ].
Alternatively, if the price of the stock rose, say at bid/ask of £112/£115, the investor will have a loss of £150.
Betting happens on a margin, so the investor's initial deposit is based on the margin set by the spread betting broker. Let's assume it's 20 percent. The investor will have to deposit £200 initially ((bet size x bid price) x margin%).
Spread Betting and Taxation
Spread betting can be tax-advantageous depending on where you live. In some countries, including the UK, spread betting is considered speculative betting or gambling and not an investment.
This is directly related to the fact that you're not actually buying or selling the asset in spread betting. You're just speculating the price rise or drop.
In the UK, spread betting is completely tax-free. There's no capital gains tax or stamp duty on the earnings you make from financial or sports spread betting. The spread betting broker may be liable for taxes, but individuals on the platforms are not liable for any taxation.
At the same time, losses in spread betting cannot be used to offset any other capital gains.
On the other hand, spread betting is also illegal in some countries, including the US and Australia.
Is Spread Betting Risky?
Spread betting is a high-risk investment strategy for a variety of reasons. Commonly, bad use of leverage, margins, market volatility, and higher spreads are the reasons behind the high risks.
As is common with leveraged trading of any kind, there's the risk of using your entire deposit or even going into negative territory on a particularly bad day. Then there's the risk of account closure because of rapid and unprecedented changes in the market.
Wide spreads increase the risk even further, which is common for spread betting companies in volatile periods.
How Can I Mitigate Risks?
Spread betting risks can be reduced by maintaining leverage limits, ideally at 2 percent of investment capital.
Stop-loss orders can also mitigate risk or, at the very least, reduce losses. A trade automatically closes with a stop-loss order once the price reaches a threshold. The stop-loss order can be standard or guaranteed, with the latter offering more protection.
Spread Betting Alternatives
Spread betting is not for everyone because there's a lot of speculation, and any misstep can result in heavy losses. There are safer, more traditional alternatives, including direct trading of stocks.
Other trading options less risky than spread betting include forex. Surely these investments require more initial capital, but the risks are considerably low, plus there are chances of high gains in the long run.
Best Spread Betting Platforms in the UKCFDs vs. Spread Betting
Contract for difference (CFD) and spread betting are remarkably similar trading instruments. In fact, you may find both these options on the same broker platforms. With CFDs, traders can bet on price changes for an asset without owning the asset.
CFDs are available for stocks, commodities, forex, and indices like spread betting. CFDs are trades based on future price movements, but these are not futures. These trade very similar to other securities.
Unlike spread bets, CFDs don't have an expiration date. Spread bets have an expiration date when the bet is placed.
CFDs, like stock trading, may have commissions and fees, which spread bets do not have. However, CFDs are also leverage-based trading, so an investor does not have to commit 100 percent of the trade initially, only the margin.
Best Spread Betting Brokers
Now that you know what is spread betting and its pros and cons, here are the two best spreading brokers you should consider:
IG
IG is the company that started spread betting, so it's not a surprise that it's the biggest broker of spread bets in the world. It has an extensive range of investment instruments, including spread bets and CFDs.
It's regulated by the FCA, CFTC, and NFA in the US. It offers account protection and guaranteed stop losses as well (not for US clients).
The reason why it's the best is that there are a lot of learning resources, so investors can learn to trade with spread betting quickly.
AvaTrade
AvaTrade is not a spread betting broker but a forex and CFD broker, which the Central Bank of Ireland regulates. However, it can be a good place to start with CFDs and before moving on to spread bets, as it's designed for novice traders.
It's headquartered in Dublin, Ireland, but operates in many other markets. While it's regulated in Ireland, it's not regulated in the UK by the FCA.
AvaTrade also offers cryptocurrencies. It also has negative balance protection, which helps mitigate risk with CFDs.
FAQs
What is spread in trading?
Spread is the difference between the price you can buy an asset at and the price you can sell an asset at. It's the difference between the bid and the asking price.
What can you spread bet on?
You can spread bet on shares, commodities like gold or silver, indices like the UK 100, and foreign exchange pairs like GBP/USD or EUR/GBP.
What is the minimum deposit for spread betting?
The minimum amount needed to start spread betting may vary by the broker. With some brokers, you can start with just 100 quids.
Is spread betting legal?
Spread betting is legal in the UK and many other European and Asian countries. It's illegal in the US, Japan, and Australia.
Team that worked on the article
Chinmay Soni is a financial analyst with more than 5 years of experience in working with stocks, Forex, derivatives, and other assets. As a founder of a boutique research firm and an active researcher, he covers various industries and fields, providing insights backed by statistical data. He is also an educator in the field of finance and technology.
As an author for Traders Union, he contributes his deep analytical insights on various topics, taking into account various aspects.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
The topics he covers include trading signals, cryptocurrencies, Forex brokers, stock brokers, expert advisors, binary options. He has also worked on the ratings of brokers and many other materials.
Dr. BJ Johnson’s motto: It always seems impossible until it’s done. You can do it.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.