What is Spread Betting?
Spread betting is a term that can refer to other areas, such as gambling or sports betting, and any other avenue where bets are placed, based on the outcome of a potential event or activity. Because this spread betting guide is geared towards financial market traders, the focus will be placed on spread betting in relation to these markets. With that said, traders need to understand why spread betting is so popular and how it can be used to take advantage of market positions to make a good return on investments. Spreading a bet is not only a good position to hold for profit purposes, but it is also good for tax efficiency. It allows traders to speculate on the expected price fluctuations of just about any financial investment instrument.
- Stock indices
This speculation, which is based on factual market information and research, allows the trader to take up a specific market position to match this speculated notion. The idea behind spread betting is not for traders to stray away from owning specific underlying financial market instruments, but rather entering into contracts and forward positions that allow them to take advantage of the price changes of the asset over a period of time. It is therefore prudent that this understanding is solidified within the traders mind, allowing them to act according to market movements as opposed to solely relying on raw instinct.
Exploring the Mechanics of Spread Betting
The fact that spread betting allows traders to enter into two different market positions can prove to be a good thing, however, caution and prior understanding of market speculation is necessary to ensure that the spread betting strategies work. At its core, the act of spreading a bet involves taking a position (sometimes multiple positions) based on how you think the instrument will perform in the future. When taking a position, there are two factors to note: the ask price and the bid price. The bid is the price at which a trader can buy the asset, and the ask is the price at which the trader can sell the asset. Between these two potential positions is what is known as the spread. Thus, you are speculating whether the price or value of the underlying asset will be higher than the offer price or lower than the bid.
Speculation cannot be done on a whim or gut feeling (although this has worked for some). It should be based on facts, calculated projections and a little bit of instinct. Before taking a position, it is only prudent that you decide the underlying asset of your choice. Market research ensures that the decision-making process is not a blind attempt, but an action backed by facts already acquired. Spread betting uses leverage, as opposed to actually owning the asset, and you would only need a minor deposit amount on the value of your position.
The Benefits of Learning How to Spread Bet
Spread betting comes with a number of benefits. The trader needs to examine each of these and consider whether to proceed with actioning a spread bet. The benefits of spread betting are:
- Holding long and short positions
- No commissions imposed
- Tax efficiency and benefits
By knowing how to spread bet, you are afforded multiple benefits. Firstly, spread betting allows you to take long and short positions, which means exploiting future and short-term price speculations. This also means you can bet on both the rise and the fall of an instrument, and the fact that you don’t own the asset you are betting on means you don’t need to “physically” hold the required position. It also means you don’t need to borrow any shares to short sell them. Secondly, spread betting traders needn’t worry about commissions. This is because spread betting brokerages make their profit from the spread prices they offer. Therefore, most importantly, there are no commission charges on profits. This is great news for the trader looking to avoid high trading costs. Thirdly, spread trading has significant benefits owing to the fact that it is considered gambling (which is the case in the UK), and any capital gains and profits made from a spread bet are not taxable.
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The Limitations of Spread Betting
On the other hand, spread betting also has certain risks and limitations that present themselves. You need to take note and understand how these can pose a threat to your own investments.
- Margin calls on accounts
- Wide spreads
- High trading costs
As mentioned earlier, traders don’t need to pay the full value of their position. You can simply pay a deposit percentage, which is referred to as the margin. However, spread accounts also have margin requirements (essentially the percentage of funds that always need to be present in the trader’s account). If and when the funds in the account fall below the required margin, you will receive a margin call. Depending on how you have been using the funds in your account, a margin call can be especially high.
The second limitation of spread betting is the potential of an instrument having a “wide spread”. This often occurs during periods of volatility, which results in brokerages tightening their belts and widening their quoted spreads. With this in mind, the issue of a broker comparison becomes a central point of observation. A wide spread triggers stop losses, which also triggers higher trading costs. Traders are advised to refrain from placing any bets right after a company is about to release financial annual reports or any other announcements that may affect the stability of the stock or asset.
How to Manage Risks Associated With Spread Bets
The fact that spread betting uses leverage as its basis of profit making presents you with certain risks to hedge against. Taking a market position and investing in that position, no matter how small the investment is, poses certain risks, especially if you are misinformed about how the market will actually perform. Therefore, it is important to know and understand your intended trading market fully. This includes any underlying volatility and how the entire structure moves.
Despite all these risk, traders learning how to spread bet have ample tools available that they can employ to shield themselves from losses associated with risks. Deployment or utilisation of these tools ensures that emotional spread betting is replaced by logical and strategic methods. Without this knowledge, chances of success can easily diminish as opportunities are lost due to lack of skilful application of the trading tool.
These tools come in the form of stop loss orders. The first stop loss you can use is the standard stop loss. This reduces risks by spontaneously closing out the trader’s position once the market exceeds a set price. The loss will close out your position for the best possible price available in the market at the time. The second stop loss order option is the guaranteed stop loss. This works in the same way as the standard stop loss, however, this one only closes your position at the exact value you have set it to, making it a guaranteed stop on your position.
How to Create Arbitrage Through Spread Betting
One of the most lucrative aspects of spread betting is the fact that it is a vehicle of risk hedging. Spread bets can be used on any number of assets, which allows this form in trading strategies to be the perfect tool for portfolio diversification. You can take multiple positions at any term in any location on any instrument to hedge against volatile market prices and changes. This can create portfolio arbitrage for a number of investors and traders. An arbitrage is an opportunity that arises when the price of identical instruments varies from one market to the next among separate companies. This overview allows you to access which instrument is most likely to be viable, though further analysis is required and deemed essential. This creates a gap, where the asset can be bought in one location at a lower price and sold in another at a higher price.
Creating spread betting arbitrage occurs when investors are equipped with the knowledge and information to exploit these market efficiencies. However, this same knowledge and information limits arbitrage opportunities from lasting too long, and since this information is spread across markets, as each market adjusts the arbitrage is lost.
Spread betting arbitrage can still, however, be sustained, even when the market adjusts. To achieve this, the arbitrageur spread bets on two separate companies. Whenever a top-end spread that one company is giving goes below the offering of the second company, an arbitrage gap is created.
A Synopsis of Spread Betting
Spread betting is an action in trading that holds numerous benefits for traders who are looking to not hold or own an asset. This enhances the opportunities for successful trading, as not everyone is interesting in ownership. It allows you to hold market positions without having to invest the full value of the underlying asset’s price. Spread betting can be tricky, and because it is solely based on speculation, it needs to be practiced with caution. The fact that traders and investors have access to resources, such as charts, market research, future forecasts and projections, allows you to take a position from a more informed standpoint.
However, even this is not enough to always protect you from the risks associated with spread betting. In fact, some countries go as far as regulating spread betting as gambling and not necessarily investing. This has its benefits, as the government treats any earnings and profits earned from spread betting as gambling winnings, therefore they are tax free. Another benefit of spread betting is the fact that it can be used to hedge against risk, as many different positions can be taken in both the long run and short run. Spread betting is a form of portfolio diversification and if implemented precisely and accurately allows you to create arbitrage positions that produce profits. Spread betting can be an advantageous addition to your trading portfolio and boost your income when pursued correctly.