The basics of financial spread betting explained, plus top spread betting tips.
What is spread betting?
Financial spread betting allows you to benefit from share movement within the stock market and a number of other financial indices and markets, without actually purchasing the stock itself.
Shares traded are assigned a lower 'sell' price and a higher 'buy' price by financial spread betting companies, with the difference between these prices known as the spread.
Companies compete to offer the most attractive financial spreads on shares, the size of each spread measured in points or ‘pips’. As an investor you buy theoretical shares of commodities or their markets through an account with a spread betting company.
Spread prices are regularly updated relative to the shares’ actual stock market performance, so profit or loss is made on the difference between the new spread prices and the prices that you invested at.
One of the main advantages of financial spread betting over traditional share dealing is that bets can be placed on the downward movement of an index or share price. As such they are often used to hedge against losses made from decreasing share values.
How to open a spread betting account
Before you begin trading, you need to open a spread betting account with a spread betting company. This involves depositing a sum of money into an account, from which you can invest in the company’s spreads.
Financial spread betting companies usually offer a range of different accounts tailored to different types of investor. Some may impose minimum initial deposits, but mitigate this through narrower spread prices or bonuses.
Financial spread betting offers are often available on certain accounts to tempt you to invest with them rather than a rival; companies can offer to match your initial deposit, or a percentage thereof, giving you more ability to invest.
The best financial spread betting company for you will depend on the size of the initial sum you are able to invest, the incentives offered by a company based on this figure, and the actual spreads they offer.
In general, narrower or smaller spreads (fewer pips) are more attractive to investors as share values don’t need to change as much before you can sell – or buy back – shares at a profit.
Basic spread betting techniques
Here's an overview of the basic financial spread betting strategy:
If you believe that the value of an index will rise compared to that quoted in its spread prices, you 'buy'. Although this is only theoretical; you never make an actual share purchase.
Instead, you invest a stake per point of movement (‘pip’). Because the original ‘buy’ price is high, you need to wait until the lower ‘sell’ price moves above it before you can sell your stake back at a profit.
You make profit on the number of pips the spread’s sell price moves above its buy price, proportional to your original investment.
If you believe that its value will decrease, you 'sell'; again this is based on the theoretical sale of shares you don't actually own but later hope to buy back at a reduced rate.
Once the ‘buy’ price falls below the price you sold at, you can buy the shares back for less (the company you have your account with refunds difference, paying the price per ‘pip’).
If an index moves as you predicted between the time you buy and sell, your profit will be the difference in points or value multiplied by your stake per point of movement (‘pip’).
Conversely, if it moves against your prediction this will be the amount you owe. You can close the spread bet at any time, i.e. to maximise profit or cut your losses.
It can be tempting to look at short term spread betting as a way to make a quick buck, but it’s important that you realise how quickly markets can change in the short term. One minute they might be in your favour, the next they could be against you.
There is no limit on the number of points above or below the spread that your chosen index will rise or fall, so your potential profits in financial spread betting markets are uncapped. This means that you could see a much greater return than you would have if you'd simply invested in the commodity itself.
Profit and loss
However, as the returns can be magnified, so can the losses and if the market moves against your prediction, you will be responsible for paying out the difference, still multiplied by your stake per pip.
This makes financial spreads very volatile investment and you need to be fully aware of the potential losses before you start.
Most financial spread betting companies offer access to certain mechanisms which you can use to minimise the risk of a big loss. One example is a 'stop loss order' which automatically closes the bet if the index moves a specified amount against your prediction.
Spread betting and margin trading
Spread betting works based on margin trading , which means that when you place a bet via financial spread betting accounts you only have to hand over a deposit instead of the full bet amount.
Theoretically this means that you have more money to use in alternative investment opportunities, or conversely allows you to stake a larger position on each point in the bet than you would have been able to otherwise (known as gearing).
However you must have access to the total amount to cover costs should the bet go against you. Some spread betting brokers offer credit accounts for this reason – you can check this through financial spread betting comparison.
A major advantage of spread betting is that although many consider it to be a form of financial trading, because of the high level of associated risk it is classed as gambling under British law and so is exempt from capital gains tax and stamp duty meaning that all profit made in the spread bet is kept.
Risks of spread betting
Although financial spread betting can be an exciting way to make potentially unlimited profits it is also a highly risky form of 'investment' and should only be undertaken if you have other secure financial arrangements in place, plus access to the finances to cover any losses.
Additionally, it is important to bear in mind that like winnings, unless you place a stop loss order on your bet, your potential losses are also unlimited. For this reason it's important to thoroughly research your bet prior to placing it and choose the best spread betting platform so you can easily and quickly monitor and control your bets.
If you compare financial spread betting companies you will be able to identify the best spread betting account for your purposes, including how to manage it (its platform). Spread betting accounts can usually be managed online or by phone, so decide which is easiest and most intuitive for you.
As long as you 'play' with money you can afford to lose, research the object of your bet thoroughly and guard against potential losses, financial spread betting online can be a profitable way to gamble with the stock market.
If you're new to spread betting it is a good idea to build your experience using a spread betting demo account before you risk any of your money. Getting practice with an online financial spread betting simulation in this way is a safe means of familiarising yourself with the techniques you'll need to master.
Once you're used to it, you can graduate to a full online spread betting account with the same provider – or compare its peers to find the best account for your style of trading.