What does spread mean in trading?
The spread is the difference between the buy and sell prices of financial instruments, such as securities, commodities, and indices.
The buy price, also called the bid price, is the highest amount a buyer is willing to pay for a given financial instrument. The selling price, also referred to as the asking price or the offer price, is the lowest price a seller is willing to accept to sell a financial instrument.
What is spread betting?
Spread betting, also known as spread trading, refers to a trading strategy that enables traders to speculate on the price movements of numerous financial instruments, such as shares, commodities, indices, and currency pairs.
It is a legal and feasible alternative to traditional trading, enabling traders to profit from upward or downward price movements of financial instruments without actually owning the underlying instrument.
Features of spread betting
Choice to ‘go long’ or to ‘go short’
After receiving the ask and bid prices from the broker, the trader bets on whether the price of the underlying asset will be lower than the bid price (decrease) or higher than the ask price (increase).
If the assumption is that the price will rise, the strategy is to buy and sell higher, referred to as ‘going long’. If the expectation is that the price will fall, the strategy is to sell and buy lower, known as ‘going short’.
The aim is to generate profits from speculating on the increase or decrease of the underlier’s price. However, if a price does not move as expected, a trader can incur losses.
Leverage in spread betting
In trading, leverage refers to the strategy where a trader is allowed by a broker to trade with a large amount of money, using almost none of his or her own funds. Brokers allow the use of leverage through margin trading, where a broker lends funds to a trader.
Leverage plays a major role in spread betting, enabling traders to have full market exposure for a small amount of the money actually required to trade.
Leverage enhances profits and losses because they are calculated according to the full amount of the trading position of a trader, not only to the value of the initial deposit.
Margin in spread trading
When you open a position in spread betting, you will be required to deposit a percentage of the full amount of the trade in your spread betting account. This initial deposit is called the deposit margin.
The other type of margin involved in spread betting is the maintenance margin, indicating the additional funds that might be needed to keep your position open when you start to suffer losses that are not covered by the deposit margin.
How does spread betting work?
The spread
The term spread in spread betting refers to the difference between the buy and sell price of a given financial instrument as quoted by a spread betting broker or brokerage. Put differently, spread is the charge paid by a spread bettor (trader) to open a trading position.
Typically, the costs of any given spread trade are included in the bid and offer prices. Therefore, a spread bettor will always buy marginally higher than the market price and sell marginally below the market price.
The stake
The stake, also referred to as the bet size, is the amount a trader bets how much an underlying asset or underlying market will move ‘per point’.
A point of movement can represent €1, $1, R1, £1, or one unit of whichever currency you prefer to trade with. It can even be as little as a cent, penny, or the smallest unit any given currency is divided into.
The size of a point depends on, among other things, the underlying asset or liquidity and volatility of the underlying market.
For example, if you open an R2 per point bet on the share price of company ABC and it moves 50 points in your favour, your profit would be R100 (R2 x 50 points). Contrarily, if the price moved 50 points in the opposite direction of your bet, you would incur a loss of R100.
The bet duration
The bet duration is described as the length of time before a position in spread betting expires. Although having fixed timescales, bet duration can vary from a day to several months. However, spread bets can be closed at any point before the nominated expiry date, supposing the spread bet is open for trading.
Example of spread betting
Let us say company ATZ is currently trading at a sell price of 25020 (R250.20) and a buy price of 25070 (R250.70). Expecting the share price to rise in the next week, you decide to go long on ATZ’s shares, betting R5 per point of movement at 25070 (R250.70).
Two outcomes are possible:
- Gaining a profit
As you have anticipated, the share price did increase, and you decide to close your position at the sell price of 25130 (R251.30).
Results:
- The movement in points = 60 points (25130 – 25070).
- 60 points x R5 stake (bet size) = R300 profit. (Excluding any additional costs.)
- Incurring a loss
Contrary to your expectation, ATZ’s share price declined to 24910 (R249.10). To cut your losses, you decide to close your position and sell the shares immediately.
Results:
- The movement in points = 160 points (25070 – 24910).
- 160 points x R5 bet size (stake) = R800 loss. (Excluding any additional charges.)
Some advantages of spread betting
- Access to numerous financial markets.
- Potential of substantial profits.
- No commissions or broker’s fees. Spread betting brokers and brokerages earn their money through the spread they offer.
- Trading on margin (leveraged trading), implying you can start trading with a small amount of money. Leveraged trading enables you to generate profits far in excess of your initial deposit.
- Access to 24-hour markets.
- Spread bettors can simultaneously go long and go short. To the contrary, traders who trade on a stock market have to rely on the shares to increase in price, to profit from their trades.
- Profits gained from spread betting are tax-free in certain countries.
Some risks pertaining to spread betting
- If the price movements go against your bets, your losses can also be substantial. The key principle in this regard is, never risk more than you can afford to lose.
- Trading with leverage can also amplify losses. A trader who does not understand trading on margin can take positions that are too large for his or her margin account, resulting in the dreaded margin call from the broker.
- Wide bid-ask spreads may occur during periods of volatility, triggering stop-loss orders and increase trading costs.
Risk management
Keep in mind that not every trading strategy is suitable for every trader. Assess your risk appetite and create a risk management strategy that suits you. Take time and develop your own spread betting strategy.
Find a professional and trusted spread betting broker or brokerage who can provide you with outstanding platforms in order to lead you into the world of spread betting.
Lastly, spread betting provides effective trading tools to mitigate losses.
- Standard stop-loss order – Automatically closes out a trade once a market price rises or drops below a specific price level.
- Guaranteed stop-loss order – Guarantees to close a trade at the exact price a trader has set, regardless of the underlying market conditions. It provides greater certainty than a standard stop-loss order. However, your broker will levy an additional fee.
Note: This article does not intend to provide investment or trading advice. Its aim is solely informative.
Top 4 Brokers
