Spread betting is a form of speculation that involves betting on the direction of financial markets, such as the price of stocks, indices, currencies, commodities, or other financial instruments, without actually owning the underlying asset. It is a popular form of trading in the UK and some other countries due to its tax advantages and the leverage it offers. Here’s how a spread bet typically works:
1. **Choosing a Market**: Traders select a market they believe will move, such as the FTSE 100 index, the price of gold, or a currency pair like EUR/USD.
2. **Buying or Selling**: Traders decide whether they think the price of the chosen market will rise (go long) or fall (go short).
3. **Spread**: The spread is the difference between the buy (bid) price and the sell (ask) price. When you open a position, you enter at the buy price if you’re going long or the sell price if you’re going short. The spread represents the cost of trading and is how the spread betting provider makes money.
4. **Stake**: Unlike traditional share trading, where you buy a certain number of shares, in spread betting, you ‘bet’ a certain amount per point of movement in the market. This is known as your stake. The more the market moves in your favor, the more you will earn; conversely, the more it moves against you, the more you will lose.
5. **Calculating Profits and Losses**: Profits and losses are calculated by multiplying the number of points the market has moved by your stake. For example, if you bet £5 per point and the market moves 20 points in your favor, you would make a profit of £100 (20 points x £5 stake). If it moves 20 points against you, you would lose £100.
6. **Leverage**: Spread betting is a leveraged product, which means you only need to deposit a small percentage of the full value of the position to open a trade. This can amplify both gains and losses.
7. **Margin**: Because of leverage, you need to maintain a minimum amount of capital in your account to keep your positions open, known as margin. If your losses deplete your account balance to below this margin requirement, you may face a margin call, requiring you to deposit more funds or close out your positions.
8. **No Stamp Duty or Capital Gains Tax**: In the UK, spread betting is free from stamp duty and capital gains tax, making it an attractive option for some traders.
9. **Closing a Bet**: To close your position, you take an opposing bet to the one you opened. If you initially bet that the market would rise and it did, you would sell (at the sell price) to realize your profit. If the market fell, you would buy (at the buy price) to close your position and crystallize your loss.
10. **Stop-Loss and Take-Profit Orders**: To manage risk, traders often use stop-loss orders to automatically close a position if the market moves against them by a certain amount, and take-profit orders to close a position when the market has moved in their favor to a predetermined level.
It’s important to note that spread betting carries a high level of risk, particularly because of the leverage involved, and losses can exceed your initial deposit. It is essential for traders to understand these risks and to employ risk management strategies.