What is spread betting?
Spread betting is a tax-free method of trading derivatives on a trading platform unique to the UK citizens.
Why is spread betting so popular?
The profits of spread betting are tax-free and you don’t have to pay any stamp duty because you don’t take ownership of the underlying asset.
You can trade tens of thousands of instruments on global markets, including foreign-exchange pairs such as the EUR/USD.
You can go long when you believe the price of an underlying asset will rise, or go short when you think the price will fall.
You can place your trades “on the go” via an app on your mobile device, or in your home on a laptop or desktop. It’s easy to sign up with a broker, and there are lots of them to choose from.
You can benefit from leverage, whereby you only have to place a small deposit, or margin, to make a relatively large trade. Suppose, for example, you want to open a position in Tesla shares worth £2000. The broker might offer you leverage of 5:1, so you would only have to put down £400. But you should remember this means that any losses, as well as profits, could outweigh your initial deposit, as both are calculated on the full position size.
You don’t pay any commission to the broker, as they make their money from the spread.
You don’t need to take physical delivery of the underlying asset you are trading.
You can access financial products that may not otherwise be available to you, including stocks listed on foreign exchanges and derivative instruments (such as futures contracts) that may otherwise have substantial minimum investment requirements.
You can close a position at any time during the trading day. That means you can hold a position for as long as you want, be it seconds, minutes or hours. You can even hold a position overnight, although there will be a charge for doing so. Moreover, many brokers offer a variety of options when it comes to trade size, allowing a wide range of traders to access the market. This includes beginners and casual traders seeking to experiment with investment strategies while limiting their risk by focusing on small trades.
You can use spread bets as a way of “hedging” or offsetting your trading positions with balancing trades in case your beliefs about whether those initial positions are likely to rise or fall prove wrong. Spread bets are ideal hedging tools because you can use them to bet that an instrument will rise or fall at a relatively low cost. So, you can take a long position in shares in XYZ that will profit should the price rise, while taking out a short position that will prove profitable should the XYZ share price fall. In other words, instead of selling XYZ at a loss should your expectation of the share price moving higher prove wrong (and draining your limited financial resources in the process), you can open an additional short position that will generate earnings to help offset any losses from your initial position.
You can also use spread bets to insure against a rise or fall in any investment you have. Suppose, for example, you have a standard portfolio of shares in global equities that you wish to keep invested for the long term. Now imagine you anticipate that global equities will soon encounter turbulence and fall sharply before correcting. You could sell all the shares in your portfolio in the belief that you’ll be able to buy them back at a much lower price. But that could prove costly in terms of transaction expenses and taxes, and it is risky: global equities might rise sharply and you might not then be able to buy them back at a lower cost. Alternatively, an investor fearing a market correction could short-sell an equivalent amount of spread bets in an index of global shares, enabling them to take advantage of the short-term downtrend. At the same time, the investor continues to hold the shares within the investment portfolio, in the belief they will thrive in the long term.
How does spread betting work?
The easiest way to understand spread betting is to think of how a car dealer works. They buy cars at one price and then sell them at a higher price, and the difference between the two prices, or the “spread”, generates their profit.
Spread betting works in exactly the same way. In financial markets, you generally see two prices quoted for an instrument, such as a currency pair. For example, if you are trading the euro against the dollar, you will see an offer (or ask) price and a sell (or bid) price quoted for the currency.
You place a spread bet based on whether you expect the price of an instrument to rise or fall. If you anticipate the value of a stock or bond will rise, you would open a long position, where you are the buyer. By contrast, if you expect the price of the financial instrument to fall, you would take a short position, where you are the seller. You will make a profit or loss depending on whether or not the market moves in the direction you expect.
What is the spread?
The price at which traders can buy a financial instrument is always higher than the sell price, and the difference or “spread” provides the broker with a small profit to finance their operations. A wider spread means there is a greater difference between the two prices, and that is usually an indicator of low liquidity and high volatility. By contrast, a tighter spread indicates low volatility and high liquidity. The larger the spread, the greater the costs incurred by the trader.
Spreads are measured in “pips”, or price interest points, a measurement of the smallest price move that a financial instrument can make. Most currency pairs, for example, are priced out to four decimal places and the pip is the last decimal point. So, if you are trading the euro against the dollar, you may see the following quote on your screen: “EURUSD – 1.1453 – 1.1456”. In this case, the spread is three pips: the difference between the bid price of 1.1453 and the ask price of 1.1456.
To use another example, suppose you decide to trade the FTSE 100 index, which measures movements in the prices of the UK’s biggest 100 quoted companies. If the FTSE 100 is trading at 5885.5 and has a one-point spread, it would have an offer price of 5886 and a bid price of 5885, as depicted in Figure 1.
Figure 1: Spread on the FTSE 100 Index. Source: IG Markets
What is the bet size?
The bet size in spread betting refers to the amount you wish to bet per unit of movement in the instrument you are trading. Imagine, for example, you think the FTSE 100 is going to rise and you open a £5-per-point bet on the index. If the FTSE does indeed see a gain, rising by 60 points, your profit would be £300 (£5 x 60), whereas if the index declined by 60 points you would suffer a £300 loss
Brokers measure price movements in the underlying market in points. A point of movement can represent a pound, a penny or even one-hundredth of a penny. It all depends on the underlying market you are trading and the liquidity and volatility of that market.
What is the bet duration?
The bet duration is the length of time before your position expires. All spread bets have a fixed timescale, which can range from a day to several months. But you can close the bet at any point before the designated expiry time, assuming the spread bet is open for trading.
Brokers such as IG Markets offer various bet durations:
- Daily funded or rolling bets
These bets run for as long as you choose to keep them open, with a default expiry date in the distant future. They offer relatively tight spreads but are subject to overnight funding. This is a fee that you pay to hold a trading position overnight on leveraged trades. It is effectively an interest payment to cover the cost of the leverage that you are using. Daily funded bets are generally used for short-term positions because of the impact of these overnight fees.
These bets are generally used on futures contracts and expire at the end of a quarterly period – although they can be rolled into the next quarter if you inform the broker in advance. A futures contract is a legal agreement to buy or sell a particular commodity asset, or security, at a predetermined price at a specified time in the future.
These quarterly bets have wider spreads, but lower funding costs are built into the price, making them suitable for longer-term speculation. They are divided into near (less than three months), far (three to six months) and very far (six to nine months) categories, and spreads vary according to the risk involved.
You can speculate on whether the price of a futures contract will rise or fall with spread bets, as well as with Contracts for Difference (CFDs).
How does spread betting work?
The long and the short of trading
You can bet that prices will rise (going “long” in the jargon) or that they will fall (going “short”).
Look at the example below from IG Markets to see how taking out a long position works.
You believe that Barclays shares are currently undervalued at 150.25 pence and you bet that the price will rise. The dealer offers a one-point spread on this bet, so the buy price is 150.75. You decide to bet £10 per point. The share price does indeed rally, to 170.75 pence, and you decide to close your position to take your profit. Again, a one-point spread applies, so the sell price is 170.25.
The market has moved in your favour by 19.5 points (170.25 – 150.75), meaning that your profit is £195 (19.5 x £10). You won’t pay any tax on this profit. However, you would have to pay funding charges if you decided to keep your position open overnight in the expectation of further gains.
Figure 2: Going “long” on a share-price spread bet
Source: IG Markets
Conversely, if Barclays’ share price fell to 130.25 pence, there would be a new sell price of 129.75. The market would have moved against you by 21 points (129.75 – 150.75), so you would be looking at a loss of £210 (21 x £10), plus any additional funding charges.
Now imagine that you believe the S&P 500, an index that measures the performance of the leading US shares, is going to decline. The index is currently trading at a sell/buy price of 4600/4602. The broker has a 5 per cent margin requirement, so is offering 20:1 leverage. You agree to sell (go short) at 4600, with a stake size of £5 per point. The total cost to you will be 4600 x £5 X 0.05 per cent = £1150.
Some hours later, the S&P has fallen by 90 points and you close the position with a gain of 90 x £5, which is £450. Your total profit would be £450.
Leverage and margin
As we have seen, one of the advantages of spread betting is that you can magnify the impact of your bet through leverage. In other words, you only need to deposit a small fraction of the overall value of any trade. This is known as the margin. For example, if the margin requirement for a trade is 20 per cent, then you would only need 20 per cent of the full value of the trade in your account to open the position. The leverage ratio would be 5:1.
Leverage allows you to gain a larger market exposure than may be possible with more traditional forms of investing. Trading on leverage can enhance your profits, but you must be aware that it can also increase your risk, so you need to be certain of how much you are risking with each position. You can deploy risk-management strategies to provide protection against rapid market movements (see the “Risk management in spread betting” section of this article).
Below is an example from the broker City Index, which explains how leverage works when you spread bet on stocks. The same principles apply to all other financial instruments that you spread bet on.
Figure 3: Example of how leverage works in spread betting
Source: City Index
Figure 3 details the magical impact of leverage in magnifying your capital. It shows what happens when you trade the same number of shares without leverage and using leverage.
You decide to buy 1000 shares in ABC plc at a price of £5 each in the belief that the company’s profits are about to soar. If you simply bought the shares directly on the stock market, the total cost would be £5000 (1000 shares x £5 per share). However, you could achieve the same exposure by taking out a spread bet of £10 per point on the same company, and you would only have to provide a deposit, or margin, of £1000 because the broker is offering you leverage of 5:1.
Now imagine that ABC later reports that its profits are indeed much better than expected and the price shoots up to £6 per share. You can close your spread bet and take £1000 in profit, so you have effectively doubled your initial stake, giving you a 100 per cent profit margin. However, if you decide to sell all the shares you hold directly for £6000, you will also have made £1000 profit, but you will have only increased your £5000 stake by 20 per cent.
Margin refers to the amount of capital you will need in your account to cover your position. Margin requirements are expressed as a percentage of the total value of your position, and they can vary across markets. In the above example, the margin requirement is 20 per cent, but it can be as low as 3 per cent or even less.
If the capital in your account falls below a certain level, you may be subject to a margin call by your broker. This is a warning that the capital in your account has dropped below the required minimum amount needed to keep your position open. You should always make sure the funds in your account are sufficient to cover any losses from existing trades. Otherwise, there is a risk that the broker may simply close your positions, leaving you with losses.
Advantages of spread betting
The advantages of spread betting include:
- There is no stamp duty to pay, and any profits you make are tax-free.
- You can bet on thousands of financial instruments around the world, in a huge range of asset classes, from forex to commodities to stocks and bonds.
- It is very easy to trade via an online broker, either in your home or on the go.
- You can bet that the price of an instrument will rise or fall.
- You benefit from leverage, so you can gain large exposure with a relatively small deposit.
- There are no commission fees.
- You can use spread betting as a form of insurance or to hedge against losses in other investments. If you have a portfolio of UK shares, for example, you could open a spread bet that shorts the FTSE 100. Then, if shares decline, your spread bet will offset some or even all of the losses.
Disadvantages of spread betting
The disadvantages of spread betting include:
- Losses can be sudden and unlimited without a stop-loss position (see “Risk management in spread betting”).
- The leveraged nature of spread betting magnifies market movements and increases volatility.
- Spread betting on shares grants investors no entitlement to dividends or the other rights enjoyed by shareholders.
- Your losses are not limited to your original stake. If you buy £5000 of shares, for example, the most you can lose is that £5000. By contrast, with spread betting you can lose two, three or even ten times your original stake within a few minutes as a consequence of leverage. In other words, spread betting involves much greater risk than other trading strategies.
- Although leverage means you can trade a large amount with a relatively small sum, spread betting can be surprisingly capital intensive. That is because you always need to keep a large amount on reserve to cover any losses and avoid a margin call or, worse still, have the broker close your account. A bet involving £1 stakes, for example, might still require an account with £500 of trading capital to be safe and sustainable.
- Spread-betting markets can be extremely volatile. While this creates profitable opportunities, it can also prove dangerous, with prices moving sharply in either direction. This can result in significant losses amassing over a short period.
- You are entering into a contract with the broker and there is always the risk that the other party to the contract could go bust or, in the case of an unregulated broker, simply renege on the deal.
Differences between spread betting and CFD trading
Both spread betting and CFD trading are highly popular with investors. Both make use of leverage and allow investors to benefit from movements in the prices of a wide range of financial instruments. You can use either spread betting or CFDs to bet that a product will rise or fall in value.
The key difference between the two products is that profits from spread betting are free from tax, while profits from CFDs are subject to capital gains tax in the UK. Moreover, while spread betting is illegal in many markets (though not in the UK), you can legally trade in CFDs almost everywhere in the world. In addition, while you do not pay a commission on spread betting, brokers may charge a commission to trade in CFDs.
Risk management in spread betting
Given the risks involved in spread betting, it is critical that you are aware of the measures you can take to mitigate any losses.
You can safeguard against the risk of losing more than your deposit in a trade by setting an automatic stop, or limit, to define the level at which you would like your trade to be closed. A stop-loss provides you with an exit plan should a trade go wrong. For example, if you make a spread bet on a stock trading at £20 in the belief that it will go up in value, you can also place a stop-loss order at £19.50 in case your bet goes awry. This will ensure that the broker sells your stock if the price slips to £19.50, thereby limiting any losses.
Sometimes markets become extremely volatile and prices move a long way in an instant. This is called gapping and can result in what is known as slippage, where any orders you have placed may be filled at a worse (or better) level than the one you requested. You can protect against this by implementing guaranteed stops against slippage. These guaranteed stops are free to place; you only pay a premium if the stop is triggered.
A rule known as negative-balance protection ensures you can never lose more money than is in your account. UK-based brokers are required to bring negative accounts back to zero at no cost to you.
You can set up price alerts to warn you if and when markets encounter volatility.
Spread betting – glossary of terms
Ask and buy price
Spread-betting quotes are made up of two prices: the one at which you can sell (the bid price) and the one at which you can buy (the ask price). The sell price is always lower than the buy price.
Bet size
This is how much you can make or lose on a spread bet for every point of movement in the price of the market. It is also known as the stake size.
Closing
This refers to the closure of a position, and the outcome determines whether you have made a profit or a loss. You can close the position manually or you can do so automatically by implementing a stop-loss limit, which will ensure that the product is sold (or bought) when the price reaches a certain level.
Contracts for Difference
CFDs, as they are popularly known, are similar to spread betting in allowing traders to exploit rising and falling prices without taking ownership of the underlying asset.
Controlled-risk bet
This is when you implement a guaranteed stop, which ensures that the price at which you want to sell or buy a product will be implemented even when “gapping” occurs, i.e. during bouts of extreme volatility, when prices move sharply up or down.
Dealing spread
The spread is the difference between the two prices quoted on every spread bet: the buy and sell price for the same asset.
Daily funded bet
Often shortened to DFB, this term describes a position that remains open until you decide to close it. A funding fee or interest charge is applied to the account every day the position is open.
Expiration/expiry
This refers to the date and time at which a bet will close. Expiration occurs daily for daily bets or on the third Friday of the month for some monthly and quarterly contracts. All bets are settled at the relevant closing price at the time specified.
Gapping
Gapping occurs when markets are very volatile and prices move through several levels without stopping. This can be very dangerous, as the price may move so quickly that you cannot execute the trade at the price you would have wished.
Going “long” or “short”
If you believe an asset is going to rise in price, you can buy a position in that asset through a spread bet. This is known as going long. By contrast, if you think the price is going to fall, you can sell the spread bet. This is known as going short.
Leverage
Leverage allows you to gain full market exposure for a fraction of the true cost. Imagine you want to open a position in Tesla shares. To buy £5000 of shares would cost you £5000, but in spread betting you might be required to put up just a 20 per cent deposit, allowing you to bet on the movement of £5000 worth of shares for only £1000.
Margin
Trading on margin means that you are effectively putting up a small portion of the trade value (the margin) and borrowing the rest of the money from the spread-betting broker.
Margin call
A margin call is made when the equity in your account – the total capital you have deposited plus or minus any profits or losses – drops below the minimum requirement. If this is the case, there is a risk that the broker will automatically close your positions, potentially leaving you with losses. You can make sure this doesn’t happen by depositing enough funds to increase your equity above the margin requirement, or by closing positions to reduce your exposure.
Spread
The spread is the difference between a broker’s sell and buy (bid and offer) prices. This is how the broker makes its profit. The underlying asset’s value will be in the middle of these two prices.
For example, if the FTSE 100 index is at 7100, a spread-betting firm may quote a spread of 7099–7101. You can choose to buy at the higher “offer” price or sell at the lower “bid” price. In general, the smaller the spread the better, as you need the price to move less in your direction before you start making a profit.
Spread-betting strategies
There are a number of spread-betting strategies that can be deployed. Visit https://fxscouts.com/forex-education/ for more information on strategies and a wide range of additional educational material. We have detailed below some of the main strategies that you can use in spread betting.
Arbitrage
Arbitrage involves the simultaneous purchase and sale of the same asset in different markets in order to profit from tiny differences in the price. Spread betters do this when short term actions by buyers and sellers at a particular broker vary from those at another, resulting in different prices.
While the quotes listed on broker websites reflect the underlying price movements in the instruments they are based on, they are not always identical. So, a trader may be able to go long with a spread bet on a particular asset at one broker while simultaneously selling the spread bet at another broker with a higher sell price.
News trading
This strategy involves trading based on news and market expectations, both before and following news releases. You will have to act quickly and be able to make a quick judgement on how to trade a new announcement or piece of data. You will also have to be able to judge whether the news is already factored into the stock price and whether the news matches investor expectations.
The advantage of this strategy is that corporate economic and political news happens all the time, so there are always possible trading opportunities. The disadvantage is that you need considerable expertise in how markets operate and how to interpret data and news.
End-of-day trading
According to the broker CMC Markets, this style of trading requires less time commitment than other trading strategies because there is only a need to study charts at their opening and closing times.
End-of-day trading involves buying or selling near the close of the market, when it becomes clear that the price is going to “settle”. The strategy focuses on studying the current day’s price compared with the previous day’s price movements, and using that as a guide to how the market is likely to move. Traders can use various tools to limit their overnight risk, such as setting a take-profit order or a stop-loss limit.
Technical analysis
Some traders believe that prices for stocks (and other financial instruments) move in particular patterns. They rely on indicators to determine when a trend is taking hold and then trade on the basis that that trend will continue.
Technical-analysis traders begin by seeking to understand where the price is heading according to the fundamentals of supply and demand. (For example, if we are in a period of rising interest rates, the price of stocks, in general, will probably fall, since those higher borrowing costs will cool economic activity.) They then use charts that detail previous highs and lows, trend lines and patterns.
When the price of an asset is rising, a significant previous high above the current level will be an obvious target, as will an important previous low when the price is falling. Also, in an uptrend, a line on the chart connecting previous highs will act as resistance when above the current level, while a line connecting previous lows will act as support – with the reverse true in a falling market.
Swing trading
Swing trading is a style of trading that focuses on short-term trends in a financial instrument over a period of a few days to several weeks. Swing traders rely on technical analysis to find trading opportunities and then focus on taking small gains and cutting their losses quickly. If this is done consistently over time, relatively small gains can compound into excellent annual returns.
Swing traders should focus on the most actively traded stocks that show a tendency to swing within broad, well-defined limits. It’s a good idea to focus on a select group of financial instruments, and monitor them daily, so that you understand the price action they generally exhibit.
According to the investment broker Fidelity, there are a number of ways to capitalise on market swings. The company says that some traders opt to trade after the market has confirmed a change of direction, and trade with the developing momentum. But others, it adds, may “choose to enter the market on the long side after the market has dropped to the lower band of its price channel—in other words, buying short-term weakness and selling short-term strength”. Both approaches, says Fidelity, can be profitable if implemented with skill and discipline over time.
Momentum trading
This strategy can be deployed across a range of financial instruments, including stocks. According to CMC Markets, it is a strategy that is very popular with short-term traders. It runs counter to the old stock-market adage that you should “buy low and sell high”, focusing instead on buying high and selling even higher.
Momentum trading focuses on price action and price movements, seeking to capitalise on a new directional trend, rather than fundamental factors such as company results or economic growth. For example, if an asset suddenly surges upwards after the company announces unexpectedly strong profit growth, a momentum trader might try to buy shares and ride the stock’s price higher.
Spread-betting tips
Traders can make consistent profits from spread betting, but preparation is key. Follow these tips and you will maximise your chances of trading equities successfully.
Use a demo account
All good brokers offer demo accounts where you can practise trading using virtual money. You can learn how the market works, how to place buy and sell orders, and how to deploy strategies, etc. at no risk to yourself. Do this for as long as you can. If you are consistently making a profit, it might be time to sign up for a real account.
Educate yourself
Good brokers offer lots of educational material on their platforms. There is also much material on the internet – including videos and examples of trades – that can help you learn all you need to know to trade successfully.
Don’t get emotional
Trading can be very stressful. Using a demo account can help you to decide whether the stress of losing money is for you or not. It is important to keep your cool when the market turns against you and know when to exit a position and accept your losses.
How to begin spread betting
All you need to do to start spread betting is to find a broker that you like and open an account. This is simple and can be done online. You will be asked to provide proof of identity and a deposit.
You can use either an onshore broker regulated in the UK or an offshore broker. You are likely to be better protected if you use an onshore broker, since they will be regulated by a reputable authority such as the Financial Conduct Authority (FCA) in the UK. If things go wrong and your broker is registered in a country thousands of miles away, it might be difficult to gain legal redress.
However, there are advantages to using an offshore broker. The main advantage is that you won’t be subject to the same restrictions as when using a UK-based broker regulated by the FCA.
There are things you should consider whether you use an FCA-registered broker or one based offshore. These include:
- The trading experience – is the trading platform easy to use, what kind of support do they offer, and are there tools that can help with research, etc?
- Trading costs and transparency – these can vary widely from broker to broker. In the case of spread betting, these costs will mostly consist of the spreads that brokers offer. You should research which brokers offer the best spreads in the instruments you plan to trade. It is also important to be aware of the hidden fees some brokers charge, such as inactivity fees, monthly or quarterly minimums, and fees associated with calling a broker on the phone.
- Customer service – you can trade 24 hours a day, five days a week, but does the broker offer 24-hour support? Is help available instantaneously online or via the phone, or do you have to wait for a response? You can check by calling the broker at different times of the day before signing up.
- Minimum deposit – this can vary from just US$1 to US$300, but most brokers let you open an account with around US$100.
- Maximum leverage – there is a standard 30:1 ratio for UK forex brokers regulated by the FCA, but offshore brokers can offer higher levels of leverage. Some provide a 500:1 ratio.
Conclusion
Spread betting offers a number of advantages to traders. You can bet on a huge range of instruments, there are tax advantages and you can benefit from leverage. However, spread bets are complex instruments and come with a high risk of losing money rapidly, due to leverage. You need to ensure you thoroughly understand the concept of spread betting and how much money you could lose on each bet, and ensure you take advantage of the tools at your disposal to limit the financial risks you are exposed to. You should also practise on a demo account until you are completely comfortable with spread betting.
FAQ
- What is financial spread betting?
Most financial instruments are quoted with two prices: one to buy the asset and the other to sell it. The difference between the two prices is known as the spread. You can trade this spread to bet on whether the price of the underlying asset will go up or down.
- How do you start spread betting?
You can practise spread betting by opening a demo account with a broker. You can use virtual money until you fully understand how the concept works and to hone your skills.
- Can I spread bet without leverage?
You can, but leverage is one of the main advantages of spread betting. Used wisely, it can maximise the profits you can make from a set amount of money.
- How are spread bets taxed?
You don’t pay any capital gains tax on the profits of spread betting, nor is stamp duty payable. This is one of the main advantages of spread betting.
Forex Risk Disclaimer
Trading Forex, CFDs and spread betting is not suitable for all investors as it carries a high degree of risk to your capital: 75-90% of retail investors lose money trading these products.
Forex and CFD transactions involve high risk due to the following factors: Over-leveraging, unpredictable market volatility, slippage arising from a lack of liquidity, inadequate trading knowledge or experience, and a lack of regulatory protection for clients.
Traders should not deposit any money that is not disposable. Regardless of how much research you have done, or how confident you are in your trade, there is always a substantial risk of loss. (Learn more from the FCA or from ASIC)
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