OK. You’ve heard a bit about spread betting and you’d like to try your hand. Where do you start? Getting set up is pretty simple. All you need is an internet connection and an account with a spread-betting broker. Making spread bets is then straightforward – as with most things in the financial world, it’s only the jargon that makes it seem complicated. So before you make a bet you need to get to grips with the lingo.
How to bet – go short or long?
The most important decision as a spread better is whether you are going to go ‘long’ or ‘short’. Going long means betting that the price of an asset (a share, currency or commodity) will go up. Going short, unsurprisingly, is a bet that the price will fall. This is one of the main differences between spread betting and conventional investments.
For example, you might place a down bet on the FTSE 100 index at 6,000 points by ‘going short’. Ignoring any bid/offer spread (we’ll get to that in a moment), let’s say the index drops to 5,800 points and you buy it back to ‘close out’. Your profit from selling at 6,000 points and buying back at 5,800 points is 200 points. At, say, £10 a point, that’s £2,000. But remember that you’d have lost the same amount if the FTSE 100 had risen to 6,200.
Another key feature of a spread bet is that you never buy or sell the underlying asset. You just place a bet on how it will perform. This allows you to bet on the performance of more exotic markets or assets, such as Indian shares, for example, that are usually more difficult for retail investors to buy.
Once you know what you want to bet on, you need to decide how much to bet. Spread bets are settled up in ‘points’. The size of the point varies depending on the asset that you are betting on. With a share, each point might equal a penny. Say you went long BP at £10 a point. You would earn £10 for every penny the share price rises. And if the share price falls, you will lose £10 for every penny it drops. When you place your bet you will be quoted two prices – the ‘bid’ and the ‘offer’ price. If you place an up bet you will do so at the ‘offer’ price. For a down bet, you’ll open your position at the broker’s ‘bid’. This is how the brokers make their money. The gap between the bid and the offer price is called the ‘spread’. Thanks to stiff competition between providers, spreads are normally quite ‘tight’ – ie, the difference between them is small. However, don’t assume this for less liquid assets – always check first.
Leverage and margin calls
As you can see from the previous example, the point system is both an advantage and a risk. It allows you to make lots of money from small price movements, but you can make big losses too. As a result it is vital, especially for first-timers, to control the amount of risk associated with each bet.
One way spread-betting companies make you do this is through a deposit called a ‘margin’. Understandably, providers want you to back your bet with some of your own money. How much depends on the asset you bet on. With volatile, riskier plays, you need to place a higher initial deposit. A typical margin is about 10%. So if you opened a long position on BP of £10 a point at 450p a share, the total amount you could lose would be £4,500 (450 x £10) if the share price fell to zero. Since this is unlikely, you won’t pay 100% margin. A 10% margin (determined by your broker) would be £450. So with spread betting you are only putting up a small amount of the theoretical value of your position. This is called ‘leverage’.
So far it sounds like a winner. But there’s a catch. Margin stops you from racking up losses that you can’t pay back. If it looks like your losses will exceed the margin you have available, they will ask you to put up more – a ‘margin call’. If you don’t fund this call a broker can close out your position at the current price – even if that forces you to take a big loss. This is different to trading shares – if a share price drops you can simply sit and wait for it to recover.
And remember that this margin system is designed to protect your broker, not you. If you use hitting your margin limit as a way to close out trades that go the wrong way, you’ll lose money – fast. The best way to control and limit your losses is to use a ‘stop-loss’ – an instruction to your provider to close out your bet once the market price rises above, or falls below, a certain level.
However, even stop-losses are not completely secure. Sometimes the market ‘gaps’ – ie, jumps or falls sharply as many orders at the same price activate together. Your spread-betting firm may not have time to close your position until the market price has gone well past the stop-loss trigger. This is more likely to happen in illiquid or thinly traded assets. It is particularly likely overnight when the main markets are closed, but trades continue between institutions. When the main markets reopen the next day the new prices are immediately factored in.
The only way to counter this is to pay extra for ‘controlled risk bets’ or ‘guaranteed stop-loss orders’. Using these means that firms commit to close your position at the specified price. You pay extra for this – it’s reflected in a bigger ‘spread’. However, that’s a price worth paying for peace of mind, particularly in the commodity markets.
The final piece of jargon is the ‘maturity date’. This is when your bet expires and you receive your winnings or take your losses. Of course, you can choose to close the bet anytime before then. If the bet hasn’t worked out as you had hoped, most brokers will allow you to ‘rollover’ to a later date. But watch out, there is normally a charge for this too.