Spread Betting Guide
What is Financial Spread Betting?
As the financial markets gradually move away from the trading floors on major exchanges and into the homes of prospective investors using online trading platforms, financial spread betting has grown in popularity amongst a diverse set of audiences. But what exactly is spread betting, and how can we use this form of investment to profit from market changes in the values of certain assets? Here, we will define the term and look at some specific examples of how spread betting can be used to achieve long term gains when speculating on market price changes.
Spread Betting Defined
Spread betting uses derivative products to place trades and speculate on potential moves in the financial markets. A derivatives product is defined as a tradable security in which prices are “derived” from or dependant on the value of an underlying asset. Spread betting enables traders to establish positions in thousands of different asset markets, which are typically divided into several main categories: stock shares, currencies, commodities, and stock indices (among others).
Spread bets can be used to express a view that an asset’s price will move either upward or downward, and this essentially means that investors can benefit from both rising and falling markets. This poses some excellent advantages when compared to more traditional forms of investment, as any market scenario enables traders to gain monetary returns if price movements are accurately forecast. Investors with a bullish view on an asset believe its price will rise in the future. These investors will typically take “go long” that asset, which essentially means they buy the asset at a predetermined price.
In this case, profits will increase in line with the rising value in the price of the chosen asset. On the other hand, when an investor has a bearish view on an asset, the forecast is that prices will fall in the future. In these cases, “short” positions can be taken as the investor first sells the asset looking to “buy it back” later at a cheaper price. When a short sell is made,profits will be realized in the in the amount prices decline after the position is established. With short positions, it should be remembered that this investor would actually lose money if the asset price increases.
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Advantages of Spread Betting
As you can see, spread betting offers some significant advantages because investors can actually make money no matter which type of market environment is seen at the moment. Where traditional investors tend to perform well when market prices in general move higher, a spread better can actually benefit when prices when bear markets are seen and asset prices are generally in decline.
Another significant advantage of spread betting is that it allows traders to invest in “margined products.” With a margin trade, you are able to enhance your position sizes with broker-offered credit. For example, if a trader uses 10 to 1 leverage, only $1 must be deposited into a trading account for every $10 in your total position size. So, if a trader wants to establish a $10,000 position in the S&P 500, that trader will only need $1,000 in a trading account. Margin ratios are flexible, however, and in some cases can be as high as 500 to 1. Margin trading enhances the potential for gains and losses, as the price effects of the total position size are assumed by the trader. When using margin, spread betters are able to capture large rewards, in a very short amount of time and with a limited cash outlay.
What Are Spreads?
The next question you might be asking is what exactly the word “spread” refers to when we are talking about spread betting. Specifically, this refers to the price differences that exist between the “buy” price and the “sell” price. Similar to more traditional forms of investment, brokers offer two prices for each asset. The lower price is the price at which the asset can be sold, whereas the higher price is the price at which the asset can be purchased. The difference between these buying and selling prices is also referred to as the spread.
Typically, assets that are highly liquid (commonly traded throughout the market) tend to have lower spread costs. Assets that are less commonly traded (low liquidity assets) tend to have higher spread costs. It is important to keep your spread costs in mind as these will be assessed every time you place a trade and lower costs can help to improve your rates of return.
Spread Betting Example: Stock Index
Next, we will look at a spread betting example using a Stock Index (the S&P 500). Let’s assume our trading broker is quoting buy and sell prices of 1480/1481 for the S&P 500. We currently have a bullish outlook for the index and believe prices will rise from these levels. To express this view, we go long (establish a buy position) in the index, at 1481, with a position size equal to $10 per point every time the index moves upward $1, we make $10 in profit). In this case, we will not use margin.
Over the next week, positive economic news helps propel the S&P 500 higher to reach 1491, and we close out the position. Here, our profits would be equal to $100 (10 points, times $10).
Spread Betting Example: A Margin Trade
Next, we will look at the same example, and add the element of margin. With the same prices in the S&P (1480/1481) we express our bullish view on the index using 10 to 1 margin. Where before we traded at $10 per point, our enhanced position size is now worth $100 per point (maintaining the same account size), and as prices move to 1491 later in the week, our gains are now equal to $1,000. As we can see, the use of leverage can greatly alter the outcome of a spread betting trade when we speculate in the financial markets.