Spread Bet Techniques

Spread Bet Techniques

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Spread betting allows traders to bet on the direction of a financial market without actually owning the underlying security. Spread betting is sometimes promoted as a tax-free, commission-free activity that allows investors to speculate in both bull and bear markets, but this remains banned in the U.S. Like stock trades, spread bet risks can be mitigated using stop loss and take profit orders.

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Spread betting is a derivative strategy, in which participants do not own the underlying asset they bet on, such as a stock or commodity. Rather, spread bettors simply speculate on whether the asset's price will rise or fall, using the prices offered to them by a broker.

As in stock market trading, two prices are quoted for spread bets—a price at which you can buy (bid price) and a price at which you can sell (ask price). The difference between the buy and sell price is referred to as the spread. The spread-betting broker profits from this spread, and this allows spread bets to be made without commissions, unlike most securities trades.

Investors align with the bid price if they believe the market will rise and go with the ask if they believe it will fall. Key characteristics of spread betting include the use of leverage, the ability to go both long and short, the wide variety of markets available, and tax benefits.

If spread betting sounds like something you might do in a sports bar, you're not far off. Charles K. McNeil, a mathematics teacher who became a securities analyst—and later a bookmaker—in Chicago during the 1940s has been widely credited with inventing the spread-betting concept. But its origins as an activity for professional financial-industry traders happened roughly 30 years later, on the other side of the Atlantic. A City of London investment banker, Stuart Wheeler, founded a firm named IG Index in 1974, offering spread betting on gold. At the time, the gold market was prohibitively difficult to participate in for many, and spread betting provided an easier way to speculate on it.

Despite its American roots, spread betting is illegal in the United States.

Let's use a practical example to illustrate the pros and cons of this derivative market and the mechanics of placing a bet. First, we'll take an example in the stock market, and then we'll look at an equivalent spread bet.

For our stock market trade, let's assume a purchase of 1,000 shares of Vodafone (LSE: VOD ) at £193.00. The price goes up to £195.00 and the position is closed, capturing a gross profit of £2,000 and having made £2 per share on 1,000 shares. Note here several important points. Without the use of margin, this transaction would have required a large capital outlay of £193k. Also, normally commissions would be charged to enter and exit the stock market trade. Finally, the profit may be subject to capital gains tax and stamp duty.

Now, let's look at a comparable spread bet. Making a spread bet on Vodafone, we'll assume with the bid-offer spread you can buy the bet at £193.00. In making this spread bet, the next step is to decide what amount to commit per "point," the variable that reflects the price move. The value of a point can vary.

In this case, we will assume that one point equals a one pence change, up or down, in the Vodaphone share price. We'll now assume a buy or "up bet" is taken on Vodaphone at a value of £10 per point. The share price of Vodaphone rises from £193.00 to £195.00, as in the stock market example. In this case, the bet captured 200 points, meaning a profit of 200 x £10, or £2,000.

While the gross profit of £2,000 is the same in the two examples, the spread bet differs in that there are usually no commissions incurred to open or close the bet and no stamp duty or capital gains tax due. In the U.K. and some other European countries, the profit from spread betting is free from tax.

However, while spread bettors do not pay commissions, they may suffer from the bid-offer spread, which may be substantially wider than the spread in other markets. Keep in mind also that the bettor has to overcome the spread just to break even on a trade. Generally, the more popular the security traded, the tighter the spread, lowering the entry cost .

In addition to the absence of commissions and taxes, the other major benefit of spread betting is that the required capital outlay is dramatically lower. In the stock market trade, a deposit of as much as £193,000 may have been required to enter the trade. In spread betting, the required deposit amount varies, but for the purpose of this example, we will assume a required 5% deposit. This would have meant that a much smaller £9,650 deposit was required to take on the same amount of market exposure as in the stock market trade.

The use of leverage works both ways, of course, and herein lies the danger of spread betting. As the market moves in your favor, higher returns will be realized; on the other hand, as the market moves against you, you will incur greater losses. While you can quickly make a large amount of money on a relatively small deposit, you can lose it just as fast.

If the price of Vodaphone fell in the above example, the bettor may eventually have been asked to increase the deposit or even have had the position closed out automatically. In such a situation, stock market traders have the advantage of being able to wait out a down move in the market, if they still believe the price is eventually heading higher.

Despite the risk that comes with the use of high leverage, spread betting offers effective tools to limit losses .

Risk can also be mitigated by the use of arbitrage, betting two ways simultaneously.

Arbitrage opportunities arise when the prices of identical financial instruments vary in different markets or among different companies. As a result, the financial instrument can be bought low and sold high simultaneously. An arbitrage transaction takes advantage of these market inefficiencies to gain risk-free returns.

Due to widespread access to information and increased communication, opportunities for arbitrage in spread betting and other financial instruments have been limited. However, spread betting arbitrage can still occur when two companies take separate stances on the market while setting their own spreads.

At the expense of the market maker, an arbitrageur bets on spreads from two different companies. When the top end of a spread offered by one company is below the bottom end of another’s spread, the arbitrageur profits from the gap between the two. Simply put, the trader buys low from one company and sells high in another. Whether the market increases or decreases does not dictate the amount of return.

Many different types of arbitrage exist, allowing for the exploitation of differences in interest rates, currencies, bonds, and stocks, among other securities. While arbitrage is typically associated with risk-less profit, there are in fact risks associated with the practice, including execution , counterparty, and liquidity risks. Failure to complete transactions smoothly can lead to significant losses for the arbitrageur. Likewise, counterparty and liquidity risks can come from the markets or a company’s failure to fulfill a transaction.

Continually developing in sophistication with the advent of electronic markets, spread betting has successfully lowered the barriers to entry and created a vast and varied alternative marketplace.

Arbitrage, in particular, lets investors exploit the difference in prices between two markets, specifically when two companies offer different spreads on identical assets.

The temptation and perils of being overleveraged continue to be a major pitfall in spread betting. However, the low capital outlay necessary, risk management tools available, and tax benefits make spread betting a compelling opportunity for speculators.

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S pread betting techniques are very similar to trading techniques, and once you have a basic understanding of how markets work then you can apply the techniques no matter what financial instrument you are dealing with. Spread betting has the advantage over many other ways of trading in that it gives you a great deal of leverage for your money, and any profits are not subject to capital gains tax because they are regarded as the winnings.
If you are new to trading, there are some basic rules and recommendations that will help you to succeed. The first one is that you must be careful how much you can lose on any particular bet. Typically, traders will aim not to lose more than 1% or 2% of their account if the bet does not work out. This may sound very small, but it allows for the situation where you have several losses in a row, and lets you carry on trading even after a bad run.
The second concept to incorporate in your spread betting techniques is to estimate the risk to reward ratio. This is a measure of how much you think you can profit from the spread bet compared to how much you may lose. Unless you can make two or three times what you may lose, the bet is not worth taking up. This of course assumes you are disciplined in the use of stop loss orders and don’t have the tendency to move your stops further away from your entry level once a spread trade is opened.
A third guideline is that you take care not to risk too much of your account in one type of financial security, or market sector. This is because there is a correlation between the financial instruments in that market sector, and even though you are spread across several different companies a problem in the sector could take you down as if you had risked much more than 2%. Spread betting helps avoid this problem because you have a large choice of financial markets on which you can bet, but you should still be careful about correlations between performance.
To be successful at spread betting you need to study the principles of trading, and in particular how markets can be analysed to try and anticipate future direction. The techniques of technical analysis can be applied to any financial markets, and therefore you can use them whether you are spread betting on stocks, indices, currencies, or commodities.
You should study trading techniques to know when you should be in or out of the market. A frequent beginners’ mistake is to feel that they should always have a position in the market, otherwise they are not trading. The truth is that sometimes there are only second-rate trading opportunities available, and if you take these up you will achieve second-rate results. You should not be shy to wait for the right opportunities to come.
Above all, you need to have a good familiarity with your trading platform and a good charting program to apply the analysis. Depending on the level that you want to research, you may find that your broker’s charts will be adequate, although you can get better facilities from third-party software.
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Having the knowledge and being able to implement the correct spread betting strategies is what sets apart successful and constantly profitable spread bettors.
In this article, I’ll lay out my best spread betting tips that I’ve utilised over the past few years to trade spread bets profitably.
Any spread betting trader should plan their spread betting in advance.
You should be able to competently navigate your spread betting platform so you are prepared should you need to act quickly.
If you’re yet to create your spread betting account, read my article on the best spread betting brokers to help inform your decision. In the article, I review the top brokers in the UK and provide my thoughts on each.
Understanding the platform will help your spread betting as you’ll be able to take full advantage of what the platform provides.
For example, IG Index’s spread betting platform has the benefit of guaranteed stop losses.
This means that the maximum loss is guaranteed when using this type of stop loss. It also offers trailing stops, which means we can place our stop a certain amount of points below the highest price of the stock.
As the stock rises, so too does our stop, and this allows us to capture and bank more gains and profits (more on stop loss later).
A useful tip to start spread betting is to know your market and spread betting strategy before you start using real cash.
Most traders lose when trading spread bets because they don’t know what they’re trading and they don’t have a specifically defined strategy.
If you want to trade stocks and shares then take the time to understand how the London Stock Exchange operates. It is far better to do so before you lose money because you don’t know what you’re doing.
IG Index offers both live and demo accounts in order for us to practice before going live.
Having a clearly defined spread betting strategy will prevent us from jumping into positions at random and losing our money.
One way to do this is to trade specific patterns that are profitable repeatedly rather than gambling on stocks going up or down.
One profitable trading strategy is the breakout pattern… the bread and butter of my trading!
A breakout is when the price “breaks out” of a previous resistance range.
For example, in the SharePad chart below we can see the price breaking out of the red resistance line I have drawn on the chart:
As you can see, buying the stock as it broke out led to an excellent risk/reward trade which delivered a high profit…
(You can learn how to trade breakouts in detail from my free breakout guide.)
An excellent tip to abide by when spread betting is to always trade the trend.
This is because spread betting is a leveraged product and this magnifies both your gains and your losses.
By trading the trend when spread betting, you ensure that you’re trading with the wind in your sails rather than fighting an uphill battle.
Whether you are trading over a 1-minute timeframe or a daily timeframe, it’s always best to enter the trade in the direction of the trend. Doing otherwise is betting on the price switching direction.
There is a well-known trading cliche on doing this: catching a falling knife.
Enter your email to receive my free UK stock trading handbook, packed with professional techniques to manage risk and consistently profit on AIM stocks.
Running your winners is a useful tip not only in spread betting but trading in general.
When you place a trade, there are only ever four outcomes:
You want to remove large losses and instead focus on netting small wins and big wins.
The best way to achieve large wins in your spread bet account is to run your winners. This means letting your trades run and not selling too early.
By trading with the trend, you increase the chances of making tax free profits.
Cutting losses is one of the most important parts of trading. It is an oft-repeated mantra yet many traders blow their accounts because of an ability to cut their losses.
Losses work against you exponentially. For example, if you are 33% down on a trade, you then require a 50% move just to get back to breakeven.
Spread bets are also leveraged, which multiplies losses. This is bad for both your physical and psychological capital, so ensuring your losses are kept small is a useful spread bet tip to remember.
By putting a stop loss on your spread bet trade, it means you will be closed out of the position if the price should hit that level.
This protects your downside and reduces your total risk. Stop losses are a great tool for both novices and intermediates when it comes to spread betting.
By planning your stop losses ahead of placing your spread bet trade, you ensure that you’re acting rationally. Far too many traders are unable to control their emotions when spread betting and so they end up losing money and blowing their accounts.
PRO TIP : Use guaranteed stop losses when volatility in the market spikes.
Guaranteed stop losses in spread betting are stop losses only they are guaranteed by our spread bet broker.
Normal stop losses can sometimes fail to trigger because the price gaps down through your stop, for example, in the event of a profit warning where the price opens up down well below your stop loss.
Using a guaranteed stop loss means that your stops are protected by the spread bet broker and that even if the price gaps through your stop your risk and downside is still protected.
Use guaranteed stops in spread betting when volatility in the market is higher and the chance of stop slippage is increased. By protecting your downside, you’re ensuring that you’re cutting your losses and not exposing yourself to a large potential loss.
Spread betting requires margin in order to open a trade as it is leveraged. This means that you can make your capital work harder but as you saw earlier in the article, it is a leveraged product.
With a retail spread bet account, we often have 5:1 of leverage. This means that with a £10,000 account, you can take a position of £50,000. But just because you have access to leverage, it does not mean that you have to use it.
If your £50,000 position increased by 20%, then you would have a position of £60,000 and therefore your £10,000 capital would’ve returned a 100% profit of £10
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Spread Bet Techniques

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