Don’t get smashed by the spread

Watching the spread - the difference between the 'buy' and 'sell' prices - can have a major impact on your profits - or your losses. Tim Bennett explains everything you need to know.

Bid-to-offer spreads are a fact of life for spread betters. You come across them when you place bets on everything from shares to bonds and currencies. So here's a quick reminder about how they work, along with a warning that could save you a fortune.

Remember, although spread betters don't suffer a fixed commission as they would when trading shares say £9.99 per trade you will suffer any spread set by your broker.

Let's say you are planning to place an 'up' bet on the FTSE 100. You check the price at your online broker and find it is 5400-5405. Don't forget that, as with all other bid to offer spreads, the gap between the two prices represents your broker's potential profit. Also, always remember that a buyer opens a position by taking the price on the right the broker's 'offer'. A seller, betting on falling prices, would enter a trade at the price on the left the broker's 'bid'.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

So you might 'go long' for £5 per point at 5405. What if the spread moves up, as the FTSE climbs, to 5404-5409? Should you close your position? No. If you now "sell the spread" you will be selling at 5404. So you are facing a one-point loss, or £5. But if the spread moves up to say 5406-5411 then you could sell it and take away a £5 profit, (5406-5405) x £10.

As a rule of thumb, the more popular the thing being traded, the narrower the spread when you open a position and the better your chances of making money.

So now for the warning.

It's quite simple never forget that the market (other much bigger traders) in effect sets spreads. And that means when prices are highly volatile, spreads can widen sharply and fast. So you may suddenly find yourself faced with a margin call simply to run an open position because the bid to offer spread has moved out and would trigger a cash loss were you to close out.

This is a particular risk at the moment in less liquid contracts where the bid to offer spread on a spread bet is largely determined by the spread on the equivalent futures contract. If liquidity dives in the futures market, spread betting spreads can move quickly. Another consequence of a spread jumping is you may be stopped out of a trade if you have set a stop loss order via your broker. This gets annoying and expensive if you are then forced to reopen a position and reset the stop.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.