Spread Betting Guide
This financial spread betting guide is designed for complete beginners with no knowledge of the subject. We will introduce you to the financial spread betting basics and explain much of the jargon.
Financial spread betting basics
Financial spread betting, sometime known as financial betting, is an alternative method of investing in the stock market. Instead of buying a share, holding it and selling at a higher price for a profit in the traditional way, you merely place a bet on the share rising. When the share goes up in value you close the bet and take the profits. Financial spread betting is becoming ever more popular because there are a lot of advantages to trading in this way:
Advantages of spread betting
- No capital gains tax or stamp duty
- No commission or fees
- Higher profits from small share price movements
- Ability to start trading with a small capital outlay
- Ability to make money when shares fall
- Easy to trade a wide range of 'instruments': shares, stock markets, currencies and commodities (such as oil and gold)
- Spread the risk by trading on markets around the world from a single account
Ability to trade out of hours when markets are closed - Ability to trade amounts smaller than the usual minimum for buying shares
- Credit facilities often available to traders with a proven record
- Trades are immediate
- No paperwork
We will look at these advantages in detail throughout the course of this financial spread betting guide, but first let's take a look at a specific example of traditional share investing to see how it differs from spread betting.
Buying and selling shares in the usual way
Say for example you decide to invest £1000 in Vodofone shares. At the time the shares cost £100 each and so you buy 10. Two weeks later the shares have risen to £105 so you sell your 10 shares for £1050, picking up a profit of £50.
buy at £1000 » sell at £1050 » £50 profit
Now that's a fairly straightforward example of how a trader would make money in the traditional way. Now let's see how this compares to a financial spread betting trade.
Spread betting trading
If you wanted to make a similar trade with spread betting trading you wouldn't actually buy the Vodofone shares, but rather you would place a bet. When you make an order you simply state the 'amount per point' you wish to bet. For example £5 per point on Vodofone. This means you are betting that Vodofone shares will rise and that for every point they rise you will receive £5. When we talk about a point on a share price, 1 point refers to 1p, so a rise of 100 points means a rise of £1.
If we were to place a bet of 10p per point with our Vodafone example this would end up with the same profit. The shares rose 500 points from £100 to £105. Your winnings are therefore 500 X 10p = £50.
Bet 10p per point » shares rise £5 » profit £50
If the share goes down, however, then you lose out at the same rate of 10p per point. So suppose Vodofone have a bad two weeks and instead of rising the share price actually falls from £100 to £95 then our examples would look like this:
Traditional share deal
buy $1000 » sell at £950 (10 shares at £95) » loss £50
Spread bet trade
bet 10p per point » shares fall 500 points » loss £50
On the face of it our two examples of conventional trading and spread betting trading here have the same outcome but there is a key difference. In traditional share dealing you need to hand over £1000 because you actually bought and owned the shares. In financial spread betting a smaller amount is required i.e. just enough to cover potential losses. The amount in this case would typically be around £50 but it depends on what 'stop orders' have been set. We will come to stop and limit orders in the next section of this financial spread betting guide. This smaller stake required is crucial to the earning power of spread betting which is referred to as 'leveraged' trading. In the same way that a lever allows you to lift objects normally too heavy to be lifted, financial spread betting allows you to make money on shares that you wouldn't normally have enough funds to buy. Beginners to financial spread betting need to be aware of how to manage this with stop and limit orders.
Minimize risk and lock-in profits with stop and limit orders
Because of this leveraged effect, as well as winning large profits you can also expose yourself to large losses. The way to minimize this risk is by placing a 'stop' order with your bet. In the case above you might wish to set a stop order at a level of £90. This means that if Vodofone shares drop to £90 or below your trade is automatically closed, restricting your possible losses to a maximum of £100. Setting a stop order allows you to set a high amount per point giving yourself the opportunity of large profits whilst protecting yourself from large losses in case the share moves in the wrong direction.
A limit order is also an instruction to automatically close a bet. It triggers when the share price rises to or exceeds a certain value. The idea behind this is to take your profits before the price has a chance to come down again. Learning how to decide the right level for your stop and limit orders can be the key to successful financial spread betting. If you're too cautious you risk stops triggering prematurely and taking profits too early. Set them too wide and you may risk big losses or miss taking profits when you have the opportunity. Get it just right and you can see large earnings with only occasional losses.
Making money in a down market
As was mentioned earlier in this spread betting guide one of the great advantages of spread betting is the ability to make money when share prices are falling. This process is the same as the Vodafone example above, but instead of placing a 'buy order' (betting the price will rise) you place a 'sell order' (betting the price will fall). So if you set a sell order at £1 per point this means that for every point the share price drops you are £1 richer. Likewise if the share starts to rise you lose £1 for every point. This type of trade is referred to as 'short selling' (as opposed to betting on a rising market, which is known as 'going long').
With a sell order the stop and limit orders are slightly different. Your stop now has to be set at a value above the share price, so the bet will close when the price rises too high (otherwise you will start to lose money). The limit order on the other hand, has to be at a value below the share price, because your profits are rising as the share price is falling.
The examples quoted so far have been simplified in order to explain the basics. In reality, spread betting is a little more complicated than these examples, as you need to take account of what's known as the 'spread' when working out your profits.
What is a spread?
When you trade with a spread betting account there are generally no fees or commission. The spread betting companies make money by offering a slightly different price depending on whether you're buying or selling - just as you would expect when converting currency for instance. You get quoted a different price when changing up your pounds than you would when changing back your unspent holiday euros. This difference is called the spread. A price for the FTSE 100 may typically be quoted as 4513 - 1515. The lower price is what's called the bid price and the higher price is the offer price. When you make a buy order you pay the higher price (the offer price), and when you sell you receive the lower (bid) price. It's important to be aware of the spread when making a trade. Be cautious of large spreads because a spread of say 5% would mean a loss of at least 5% built into your trade. This normally isn't a problem however, as spreads are often in the region of only 1%. Shares and markets with a large volume of trades will attract the narrowest of spreads. Spreads tend to be higher at the start and end of a trading day. If you trade on the FTSE 100 in the middle of the day you can typically get a spread of less than a tenth of 1%.
Safe spread betting guide
- Don't over-commit yourself.
- Calculate your total exposure (the mazimum you could lose before your stops kick in).
- Don't be tempted to gamble everything on one big bet: better to have a number of small trades open.
- Keep a mixture of down and up bets so if the market dramatically turns one way you're not cleaned out.
- Spread the risk: consider trading on exchanges around the world and on a variety of instruments such as commodities, currencies, shares etc.
- Make sure your account is regulated by the FSA.
- Always always set a stop (limit orders are also useful but not essential to safe trading).
- Don't bet on anything you don't understand.
- Never get into debt; only bet what you can afford to lose.
- Decide on your trading system and stick to it. If you are impetuous and change midstream you won't know if it works. All systems will have good and bad days but they generally come good in the end.
- If you can't see a trading opportunity that day - go to the pub or shopping or anything else except trade.
- Make sure you understand all the terms and conditions and settlement terms of your spread betting account.
- Enjoy yourself: it can be a lot of fun!