Spread Betting and How Financial Spread Bets Work
Financial spread betting might seem easy in concept, it is a notoriously difficult art to master, and one which requires both an intimate understanding of how transactions work, the function of markets and the tools in the arsenal to help traders respond to different situations. While there is no substitute for raw experience, having the knowledge and understanding of your instrument of choice is the first positive step towards becoming a profitable trader with long term prospects.
As distinct from regular share trading, spread betting has a number of key benefits, and offers consistent advantages over share dealing in terms of the sheer flexibility and the swift, sharp nature of returns that can be delivered. But it's wise to remember that while it is popular, it remains a sub-niche of the overall trading industry, and many traders and investors of all sizes are unprepared or simply unable to accept the risks and the downsides it can bring.
Leverage in Financial Spread Betting
Leverage plays a key role, making transactions both significantly more profitable and significantly more risky, and the burden of leverage is not one to be accepted lightly. In spread betting, unlike other forms of trading, leverage is inevitable and unavoidable. However, by taking care to ensure you understand the full implications of each transaction, and by identifying and managing the risks of each trade, it is possible to overcome the hurdles of leverage, and to apply it to your advantage.
Markets are the engine of spread bets and all financial trading, and provide the basis for placing trades. The manner in which they behave and respond to certain changes provides the volatility necessary for financial spread trading to succeed, and by understanding their inner workings, traders can come a couple of steps closer to realising their potential. Similarly, orders remain the core tools of spread bettors, implementing their instructions and delivering the flexibility necessary to guard against unwarranted risks and execute automatic trading decisions conditional on market behaviours. By understanding the way in which markets and orders interact, and the specifics of each order type, we can start to build up a picture of how the tools of the trade can be used to protect capital, maximise profits and lower the risk profile on this otherwise highly risky trading style.
Financial spread betting can be an exciting, fast-moving form of trading, and allows ordinary people from all walks of life to access the markets with very low barriers to entry. That said, the markets take no prisoners, and only by being proactive in your research, planning and strategy efforts can you give yourself the best shot at generating a consistent, aggregate profit from your trading activity.
Making a Spread Bet
When making a financial spread bet, a trader will decide on a certain amount of money to risk. For example, say you want to bet £10 per point on a certain financial product because you think it will rise in value. If you're right and the product increases its value by 20 points, you will make a total of £200 profit. However, while this might seem like the most simple of financial arrangements, it's important to remember about the spread.
With any type of financial trade, you have to pay in order to play. Because the cost of the spread is factored into any trade, the broker is always at an advantage. Because the ask price is always above the current market price and the bid price is always below, traders have to pay the difference before they even enter the market. For this reason, even with an equal risk/reward scenario, you still need more than 50 percent of your trades to be successful in order to break even.
The current spread is based on a number of factors, including the current spot or futures rate, current market liquidity, the bet size, and spreads quoted by competing brokers. For anyone engaging in financial spread betting, it's vital to pay attention to the spread and take it into account when setting up take profit and stop loss levels. At the end of the day, the size of the spread is set by the company you choose to trade with. While the house always makes money, it makes sense to research first in order to find a competitive broker with low spreads.
Simplified Trading Example
To offer a more detailed example, if the FTSE 100 stands at 7000, the provider may offer you a bid price of 6999 and an offer price of 7001. If you are still dealing £10 per point on a long trade, you will only gain the above mentioned £200 after the index has risen to 7021. If the trade goes against you and sinks to 6979, you will lose £200. However, you pay the spread whether you win or lose, an important point that all traders should never forget.
Margin and Margin Calls
Because trades can quickly go either for or against you, firms require some sort of financial protection in the form of a 'margin'. Typically around a few percent of the value of the underlying asset (margin can be much lower on popular markets), the margin is used by brokers as a way to ensure there is no risk of real loss. However, waiting for a margin call is a very bad way to trade, with most people setting up stop loss orders to close out trades at specific levels.
Orders and Execution
Normal orders are not 100 percent safe, however, especially when the market is moving so fast that lots of orders are triggered at the same time. Luckily, a number of companies offer guaranteed stop loss orders, where traders pay either a slightly higher spread or an extra fee as a way to insure themselves during times of high volatility. Stop loss orders are just as important as take profit orders, and the ratio between them is a significant part of all successful trading systems.