What is Spread betting?
Spread Betting refers to a trading technique involving speculation on the direction of a financial market without the requirement of owning the underlying asset. If you are a spread better, you will be simply speculating on whether the price of an asset will rise or fall, using the prices the broker offers you. It’s pretty similar to stock market trading as two prices are quoted.
The bid price is the price at which you can buy, and the sell price is the price at which you wish to sell. Their difference is known as the spread. Brokers offer spread betting profit from this spread, allowing spread bets to be made without commissions. Some of the key aspects of spread betting include using leverage, the availability of a huge number of markets, and being able to go both long and short. Investors go for the ask price if they sense that the market will fall. If they think the market will rise, they go for the bid price.
What contracts are available for spread betting?
Almost ten years ago, the only contracts available were similar to the futures markets. For instance, if you would like to trade the EUR/USD and it was currently May, you could only do this by purchasing a EUR/USD contract for June, September, or December. This, however, does not mean that you are locked into your trade until the contract expires regardless of what happens. You can trade out whenever you please. So if you bought a EUR/USD September contract and change your mind moments later, you can still sell out to close your position.
Another characteristic of the spread betting contracts available in the past was the prices. The quoted prices would always differ from where the EUR/USD pair was trading in the cash market. Many newcomers and novice traders mistake this act as the spread betting companies skewing their prices to reflect where it thought the EUR/USD pair would be trading at a later date. However, such is not the case, as spread betting companies do not forecast prices.
Margin trading with spread betting
When you are spread betting, you are actually trading on margin. This means that you are not required to tie up the full value of the trade and only a small portion of the total trade value. In other words, you get to control a much bigger financial position than what you invested.
To explain the relationship of margin trading and spread betting, let’s take an example. Let’s say you wanted to purchase 1000 shares of company A, which is currently trading at 100p. To conduct normal stock trading with actual shares, you would need to invest $1000 in your stockbroking account plus some extra charges associated with stamp duty and commission.
However, with spread betting, you can have the same level of exposure to company A by buying it at $10 per point. Thus your total position becomes – $10 per point x 100p entry price = $1000. However, you do not need the whole $1000 in your account to make this trade. Rather you only require the initial margin deposit as specified by your broker plus any additional funds to cover any potential running losses. Thus, if we assume that the initial margin requirement for company A is 10%, you would require just $100 to control the entire $1000 position. This is exactly what margin trading is.
This takes a different form when it comes to trading forex, as most spread betting companies do not express the margin required as a percentage of your overall exposure. Instead, they show it as a multiple of the amount you are selling or buying per point. For instance, the margin requirement for EUR/USD is quoted as “300 times stake” by your spread betting company. In this case, if you buy $1 per point when EUR/USD is trading at 1.6000, for example, then the required margin for this trade is just $300.
Why is spread betting grown in popularity?
This form of trading has been in existence since the early 1970s but has really gained popularity in the last decade. It has allowed retail clients all over the world to access and trade in financial markets. There are four main reasons why spread betting has grown in popularity.
Transparency
One of the main reasons for the appeal of spread betting is the transparency of its prices. The transparency has increased in recent years with the introduction of the daily spread bet contract. Whatever analysis you do is ultimately applied to the underlying market.
Internet Connectivity
The growth of internet connectivity and broadband services has made it possible to provide real-time data directly to the user’s desktop. Spread betting companies were among the first financial companies to offer online trading platforms and the associated tools that come with them, such as stop-losses, charting, and others.
The dot.com bubble
The dot-com bubble and its subsequent bursting at the beginning of this century were followed by the financial crisis, which was started off by subprime loans. This had forced financial markets to the front pages of our newspapers. People started becoming aware of the wild gyrations seen in financial markets. They started doubting the talents of professional financial managers. This has led many people to take a hands-on approach to their investments to see whether they could profit from some of this short-term volatility.
Competition
Increased competition in the spread betting industry has decreased the spreads very sharply. This makes spread betting a very cost-effective way of trading.
Final Thoughts
Spread betting usually guarantees an efficient way of trading a wide range of financial markets and is particularly suited to forex. The only other charges one incurs for this type of trading are the financing costs associated with trading on margin. The financing aspect is still negligible for most short to medium-term trades that one takes.