Financial spread betting
In the world of finance, there are countless methods, options, and markets available for your investment preferences. The retail traders with the highest capital and professional traders usually deal in stocks. While the remaining vast majority of the trade world takes part in part-time ownership methods. Binary options, CFDs, and spread betting are all forms of derivative trading, meaning you don’t actually take ownership of the stock you are trading but rather trading on the direction of the share price. Binary options, CFDs, and spread betting are especially popular in the UK. An example of how popular spread betting is in the Uk is that UK spread betting attracts 4 times more searches in Google than US spread betting does despite the fact that the US population is 5 times bigger than the UK population.
We do not all go into the trading world with built up capital, and these derivative trades like spread betting, present a way for us to take part in the major markets of finance. The added benefits like leverage trading also make jumping in the deep side a much cheaper choice, while increasing the chances of you drowning if you are not good at swimming. Today’s focus will be on the basics of spread betting, what it is and what makes it such an enticing and popular choice for investors.
SPREAD BETTING? LIKE IN SPORTS?
Most people are familiar with the world of sports betting. That market depends heavily on spreads and bets taken to cover said spread. This is quite similar to the financial version of spread betting. Actually, the forefather of financial spread betting Charles. K. McNeil, a mathematics teacher turned securities analyst turned bookmaker, invented the spread betting concept in the 1940s. It wasn’t till 1974 when Stuart Wheeler founded IG Index and offered spread betting on gold, that spread betting got its footing in the professional financial-industry.
In simple terms, spread betting refers to the derivative strategy based on speculating the direction of a specific financial market, without taking ownership of the underlying security. You simply place a bet on the movement of a security based on two prices offered by the spread betting company the bid and the ask prices. The difference between the bid and the ask is called the spread. As investors you are betting on if the price of the underlying security will be lower than the bid and higher than the asking price.
Your winnings and losses are determined in spread betting by the spread bet stake. When spread betting, you buy or sell a pre-determined amount per point of movement in either direction. This pre-determined amount, let’s say its $10, this number is known as your spread bet ‘stake’. For every point of movement on the price of the instruments, you will win times your stake. So, 4 point move in the right direction would mean a $40 win, or $40 loss if the price moves in the opposite direction of your bet, per each share.
BENEFITS OF SPREAD BETTING
When spread betting you are betting on your knowledge of the market across a vast variety of financial instruments. Ranging from commodities, indices, currency pairs, stocks, and fixed income securities. Not many other investment methods allow for such a wide array of financial instruments to invest in. The flexibility presented by spread betting accounts is truly unique. That’s not all either, there are several other benefits and advantages presented to you when you are placing spread bets.
Spread betting is promoted as a tax-free and commission-free activity. Granted you are paying your commission within the spread offered, but there are no extra commissions that are tied into the bet. There is a huge advantage to making tax free money however as most investment forms are subject to capital gains tax. It is definitely worth mentioning that you can long or short the share easily. Most times you have to buy or long the share but with spread betting you can also short or sell the bet if you don’t see it paying off.
Another major advantage of spread betting is leveraged trading. Leveraged trading means that you only really need a small portion of the actual stock, commodity or indices value to open a position. If you combine the derivative strategy with a leveraged investment you can buy a position to trade on a stock at anywhere from .5-25% of the value. Trading on a margin is one of the biggest draws of any investment method. It allows for the biggest returns while also risking the bigger losses when your speculation does not pay off.
RISKS & RISK MANAGEMENT
A major draw of trading on leverage for traders who are not too familiar with it, is the common mistake of taking a position that is too large for their account in margin calls. People who chase the big wins sometimes do not consider the losses they will need to cover if they are wrong.
You also should keep an eye out for wide spreads. Especially, in times of volatility, spread betting firms widen their spread to cover any possible losses or large payouts. This spread increase usually triggers the stop-loss orders setup by traders, as well as increasing trading costs for all investors. You should refrain from placing orders directly before economic reports and company earnings announcements.
A vital part of spread betting is understanding what can affect the price movements of markets. If you are not sure of the market you are betting on then you are not following a financial strategy, you are gambling.
To manage these risk factors, you can use two of the effective tools to limit your losses.
- Standard Stop-Loss Orders: A limit set by the investor to automatically close out a losing trade. Standard Stop-Loss Orders close out your trade at the best available price once your value is reached.
- Guaranteed Stop-Loss Orders: This type of stop-loss closes out your position at the exact value you have set, so you make the decision where exactly you want to get out.
SPREAD BETTING ARBITRAGE
Spread betting companies make their own spreads, this usually means bigger spreads, however, it also opens the door for something that is rarely seen in the finance world. Spread betting arbitrage allows you to take advantage of the different prices set for identical instruments in different markets. This means you can buy the item and the low price offered while simultaneously selling it at a high price. Using arbitrage transaction takes advantage of these market inefficiencies for “risk-free” returns. Of course
To break that down, if the top end of one company’s spread is less than the bottom end of another’s, you can profit from the gap between the two. It is risk-free to a certain extent, any arbitrageur could tell you, a failure for smooth execution can lead to major losses.