CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 61.4% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

How does Spread Betting Work? : Trading Guides

What is spread betting and how does spread betting work?

Spread Betting is a form of derivatives trading. It enables you to speculate on the direction that the price of a financial instrument (such as a company share, stock index, currency pair or commodity) will move. The further the price moves in the way you predicted then the more money you make. However, you can also lose money if the price moves against you.

What is leverage in spread betting?

With spread betting, you don’t actually buy the underlying asset you want to speculate on. Instead you take a view on the prices offered by a spread betting provider, such as Spread Co, as to whether the price will rise or fall. As you don’t have to buy (or sell) the underlying asset, spread betting providers allow you to trade on “margin.” What this means in practice is that you only have to put up a small percentage of the value of the underlying asset to control a large amount of it. In other words, you are dealing with leverage. As a result, your potential profits are magnified, but so are your losses. For this reason, great care must be exercised in spread betting.

How does spread betting work: ftse100 spread betting example

Spread Co is constantly making a dealing spread, or quote, on the “UK100”, based on the underlying FTSE index (the index of the top 100 UK companies by market capitalisation). This quote consists of a bid (selling) price and a, slightly higher, offer (buying) price. The spread between the two can be as narrow as 0.8 points, which means that Spread Co’s charge for opening and closing a spread bet is one of the lowest available.

It’s very important to understand exactly what “one point” means, as it varies across different financial instruments. As far as the UK100 is concerned, a point is 1.0, so if you buy the UK100 at 6920.8 and subsequently sell it at 6921.8 (in other words when our spread on the UK100 is 6921.8 – 6922.6), that is a full point. In this example, for each point the UK100 goes up, you will make £1. And one of the great advantages of spread betting is that you can speculate on a market (including individual company shares) falling as well. So if you thought that the UK100 was set to go down in value, you could have sold at 6920.0. On top of this, spread betting providers like Spread Co make two-way prices on certain financial instruments even when the underlying markets are closed. They charge a wider spread for this service, but it can be well worth it when you consider how world events and fresh news stories are moving markets all the time.

Let’s assume that you get a dealing quote of 6920.0 to 6920.8 This means that you can “sell” at the lower bid price of 6920.0 or “buy” at the higher offer (or “ask”) price of 6920.8.

Let’s say you think the index will rise, so you; “Buy” £1 per UK100 point at 6920.8.

Let’s say our UK100 rises to 6973.6 soon after you open your position and you decide to close out your bet; Your profit will be £52.80 (6973.6 – 6920.8= 52.8 x £1).

You can make a lot of money quickly from a relatively small outlay, but you can lose money fast, too. In the above example where you bought £1 on the UK100 at 6920.8. If the underlying index fell, instead of rising, and you sold your position to close at a price of 6855.4; You would lose £65.40 (6920.8 – 6855.4 = 65.4 x £1).

What is notional trading requirement?

Spread Betting providers require you to hold a certain amount of money in your account before you can open a trade. This is a deposit called the “Notional Trading Requirement (NTR)” and it varies in size depending on the market. The reason for this is that you can lose money if your trade goes wrong, or if you experience a market move against you before you are able to close out your position at a profit.

Taking the UK100 as an example, Spread Co asks for 25 times your stake as the NTR. So, to make a £1 bet on the UK100, you need to have £25 of unencumbered funds (in other words, money not needed for other positions) in your account. It is important to understand that this is the very minimum requirement though. Markets are constantly fluctuating. Consequently, it is important to have additional unencumbered funds available in the account to cover adverse market movements. If these resources get exhausted though a negative market move, Spread Co would ask you for additional funds (variation margin) to keep the position open.

How can I manage my risk?

One of the keys to successful Spread Betting is risk management. This involves carefully planning a trade before putting it on and always using a stop loss. A stop loss is an order to close out a trade at a level specified by you. So, in the above example, when you bought £1 per point at 6920.8, you could have simultaneously placed a stop loss at 6894.0. Then, if the market moved against you, and below your stop order, your spread bet would have been closed out at 6894, assuming no price gapping had occurred.

A stop loss shouldn’t be placed at any old level. It should be chosen with a careful consideration of significant technical levels (such as support and resistance) together with careful money management.

How does spread betting work: price gapping

In the above example, we mentioned “price gapping.” That’s where the market is moving fast and the price “gaps” or jumps over or below your stop-loss, without trading at that specific price. It can also happen when a lot of orders are triggered together, which often happens around large round numbers and significant technical levels.  A “stop-loss” becomes a market order as soon as the stop-loss price is hit or exceeded. This means the bet will be closed at the market price closest to the specified price on a first come, first served basis. Consequently, you may not get out at the level you expected.

Disclaimer

Spread Co is an execution only service provider. The material on this page is for general information purposes only and nothing contained herein constitutes (or should be taken to constitute) financial or other advice which should be relied upon. It has not been prepared with your personal circumstances, financial situation, needs or objectives in mind, therefore any actions taken or not taken by any person on the basis of this material is done entirely at their own risk. Spread Co accepts no responsibility whatsoever for any such actions, inactions or resulting consequences. No opinion expressed in the material shall amount to (or be taken to amount to) an endorsement, recommendation or other such affirmation of the suitability or unsuitability of any particular investment, transaction, strategy or approach for any specific person. This material has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. As such, this communication is not subject to any prohibition on dealing ahead of the dissemination of investment research. Nonetheless, Spread Co operates a conflict of interest policy to prevent the risk of material damage to our clients.