3 min read
Let’s be frank.
Spread betting is extremely risky. It’s highly dangerous. It’s not for beginners and people with lack of knowledge.
But to be totally honest, it is one of the simplest ways for an individual investor to support their ideas with hard cash. If you treat the market proper, you can get big gains, very fast.
What is spread betting and how it works?
Spread betting simply lets you guessing will the price of some stock climb or drop. You can speculate from stocks to house values.
Moreover, you don’t need to purchase the stock you want to trade. You just take a look at the prices submitted by the spread betting provider and speculate if the price will increase or decrease.
Spread betting brokerages give you a quote. The quote contains a bid price and an offer price which is a bit higher. Let’s see how it works on this example.
Your brokerage quoted some stock price at $5,000 and a spread betting provider will give you a bid price of $4,990, for example, and an offer price of, let’s say $5,010.
If you think the price will increase you can “buy” for $10 per point at $5,010. Every time the point is rising up you will earn $10. Say the price increased to $5,030. It is reasonable to close up the bet.
It is time to calculate your profit
5030 – 5010 = 20
20 x 10 = 200
So, your profit is $200.
This is in case you believe the market will grow, but if you think the market will drop, you can sell your stock at $4,990.
But you have to know that the risk is involved here. You can indeed make a lot of money with betting on small amounts but you may lose a lot too.
Let’s assume that you sell your stock for $10 per point at $4,990.
How big your loss will be if the price increase to a spread at 4,990/5,020?
Let’s calculate this.
4990 – 5030 = 40
20 x $10 = $400
Your loss is $400.
You see, you can make huge losses if your trade goes in the wrong direction. And this isn’t the only loss you may gain. Spread betting brokers will demand you to pay margin. Usually, it is about 10% but can be less or more.
The dangerous situation can arise if your losses on the trade approach near to the margin. In such a case, the broker may require more money from you and activate a margin call. What will happen if you can not come with that? The spread betting provider may close and will do, your position at a current price.
You don’t want a margin call to control your losses or you’ll be broke. Instead, set stop-loss order to close your trade at a particular price.
Let’s use our example again.
For example, you sold stock at $4,990 but you placed a stop loss at an offer price of $5,010, how big your loss would be?
4990 – 5010 = -20
-20 x $10 = loss $200
Your loss would be $200 which is pretty much less than $400.
But there is a problem with markets moving. What if it is too fast? It is gapping. A normal stop-loss order will not prevent your trade since a lot of stop-loss orders are triggered together. That will cause the trades to be closed at the market price closest to the defined price and it usually isn’t the level you wanted or expected.
The better choice is to set a guaranteed stop. This will cost you more since your broker will ask more money to get you out at a settled price. In this case, it isn’t in the question how many other stop-loss orders are activated beside yours. Actually, your broker will buy you out of the trade. This is very important when the market is highly volatile and you would like to pay a bit more to stay in a safe zone.
But there must be advantages also
One end is the tax break. In many countries (we are sure for the UK), you will not pay taxes on profits gained in spread betting or on capital gains from it. The other reason is that you don’t need to pay a fee to your broker when spread betting. Your broker will earn money from the difference between the bid and offer price.
But spread betting isn’t all about money. It is all about the opportunity to speculate on a full spectrum of markets. Even if you don’t have regular access to them. As it is said in the beginning, you can bet on almost everything. Currency pairs, stocks, commodities, whatever.