A Beginner's Guide To Spread Betting

This page aims to explain exactly what financial spread betting is, how it works and who would use it.

A financial spread betting company allows customers to bet on a wide range of financial markets such as stocks, world indices, bonds, foreign exchange rates and commodities. If you have an opinion on market direction and want to trade then spread betting is one way to achieve this.

All spread betting companies based in the UK are regulated by the Financial Services Authority (FSA). From a legal viewpoint, spread betting is classified as gambling in the UK which means all proceeds are exempt from tax.

Financial spread betting is illegal in the USA but other trading services are available for retail customers.

tax free profits

As mentioned earlier, spread betting profits are exempt from capital gains tax in the UK because it is considered gambling from a legal perspective. Any profits are also free from income tax but, if spread betting is your only source of income, then you should seek professional tax advice in order to clarify the legal position because this is a slightly grey area.

- access to a large range of markets

The largest spread betting companies offer a huge range of markets for you to trade including less conventional markets such as house prices, specific market sectors, exchange-traded funds and options.

- ability to go long or short easily

To go "short" means to bet on prices going down (going "long" is betting on prices moving up). Shorting individual shares in the stock market using a stock broker is not that straightforward to do, however with spread betting you can go long or short in any market offered with complete ease.

- low barrier to entry

Being able to open an account with a spread betting firm with just a few hundred pounds is probably the biggest attraction to many people. In comparison, if you want to open an account with a broker to day-trade US stocks, the value of your account must be at least $25,000 (due to NYSE Pattern Day Trader regulations). However, just because you can open a small account doesn't necessarily mean that you should - you should consider what the minimum bet-size allowed is and how much you are risking per trade as a percentage of your total account.

When spread betting, all market prices are defined in terms of "points". For example if the current exchange rate of the British Pound to the US Dollar (abbrieviated to GBP/USD) is 1.58039, a spread betting firm may decide that every 0.0001 change in the exchange rate represents 1 "point".

You decide how much 1 point represents in monetary terms, as long as it is within the limits allowed by the spread betting firm. For example you may be allowed to bet from as small as £0.50 per point to as much as £50 per point.

You can never buy or sell at the actual market price, you will always have to buy at a slightly higher price (known as the "ask" or "offer" price) and sell at a slightly lower price (the "bid" price). The difference between the bid and the offer price is the "spread" and is a trading cost for spread bettors.

In the snapshot of market prices above, this particular spread betting firm has simplified currency exchange rates to show that a 0.0001 change in the GBP/USD exchange rate represents 1 "point". We can also see that the "spread" (the difference between the buy/sell prices) for GBP/USD is 3 points.

A 3-point spread means that if you bought and immediately sold before the market price could change, you would end up losing 3 points - this is the cost of every trade.

You think the GBP/USD exchange rate will go up and want to risk money spread betting your opinion. The current sell/buy quote is 1.6030/1.6033. You buy at 1.6033 at £1 per point (1 point represents a 0.0001 move in the GBP/USD exchange rate).

A week later, the GBP/USD exchange rate has risen and is quoted at 1.6271/1.6274. You decide to sell at 1.6271 for a 238 point profit. At £1/point this is a gain of £238.

In reality, there is usually a small daily charge for each day that your trade remains open (very roughly 1 point per day) so profits would be slightly less.

Of course, if the GBP/USD exchange rate had instead dropped, with quotes at 1.5700/1.5703 you would be facing a loss of 333 points. Profits and losses are unlimited, so it is always advisable to define in advance the maximum amount you are prepared to lose. This is known as a stop-loss order and is normally entered at the same time as when a trade is opened.

So in the example above, if you were only prepared to risk 100 points, you would place a stop loss order at 1.5933 at the same time you bought (went long) at 1.6033. If the GBP/USD exchange rate ended up falling significantly below this level, your trade would automatically be closed at 1.6033 for a defined £100 loss.

1. The spread

You are never able to buy or sell at the market price, you must always pay a little more. This spread represents guaranteed profit for the spread betting firm - the more trades you make, the more profit the firm makes.

2. Daily charges

The most common type types of spread bets are on daily markets. This means that at the end of every day, a small daily charge is applied if a bet is still open. So the more days you leave you leave your bets open on daily markets, the more you will end up paying in daily charges (sometimes known as rollover costs).

3. Taking a position in the markets

Spread betting firms may actually actively trade financial markets themselves. This creates the potential for a conflict of interests if the firm should end up taking an opposite position in a market to the net position of its clients. In this undesirable scenario, if the clients lose money, the firm profits and vice versa.