Understanding Financial Spread Betting

The financial market has long been an avenue for speculative profits, now more than ever. Financial Spread Betting (FSB) is one option for people who look to make quick enormous profits by speculating, usually for a short term, in the financial markets. However, speculation more often than not leads to higher risks.

What is financial spread betting?

Financial Spread Betting, unlike traditional investing, is actually a form of betting. Unlike fixed-odds betting, it does not require a specific event to happen. You can actually close in the bet at any time and take home the profits or limit the losses. FSB is a margined derivative product that allows you to bet on the price movements of all kinds of financial markets and products, such as stocks, bonds, indices and currencies, etc. An investor can get into long (similar to buying a share) or short (like selling a share) bets depending on the prediction or direction the market moves.

What is a spread and why is it important in Financial Spread Betting?

A broker or trading house quotes different prices for buying and selling. The bid price is what the broker quotes for buying a stock and the ask price is the price the broker quotes for selling the stock; the difference between the two is referred as "the spread". For example, if the FTSE 100 is currently trading at 6,689, the broker may quote 6,684 as the bid price (price an individual investor could sell for)  and 6,694 as the ask price (price an individual investor could buy for). 

How to bet a financial spread?

An investor interested in betting on a financial security can risk any amount. For example, say you place £10 per point. If you think the price of the FTSE 100 is going to increase, you could place a bet at 6,694 (the ask price) and every point increase (or decrease) will translate into a £10 profit (or loss). Say you are in luck this time, and the market goes up to 6714, an increase of 20 points. Your profit will be £200 for that 20-point movement in your favor (£10 * 20 points). If the market had acted against you and the FTSE had actually gone to e.g. 6,679, you would have lost £150 (£10* 15 points). 

The broker has also an advantage to offer this type of financial strategy. As previously noted, the spread is the charge the user pays to the broker. If we take into account that the market price is actually 6,689, the ask price is 6,694 and the bid price 6,684, the investor is already at a disadvantage because the bid (or ask) price is below (or above) the market price and the investor can benefit only if the market moves further from the ask or bid price in the predicted direction.

The benefits and risks of financial spread betting?

The benefits of financial spread betting are: a low barrier to entry, access to a large range of markets, tax-free profits in some jurisdictions and the option to take either a long or a short position. Financial spread betting is very attractive because it is a way to make big profits with little investment. In most cases, you only need to post the 5-10% margin amount required. Some currency pairs and indices may have lower margin requirements. There are also no brokerage or commissions that needs to be paid. The investor can bet on a variety of markets and products including indices, stocks, bonds, currencies etc. A significant benefit of financial spread betting is the tax treatment of its profits. The profits are not subject to capital gains taxes or stamp duty, as it is considered betting and not investing. In some countries the profits may also be free from income tax if the individual does not solely depend on this practice for his livelihood. Spread betting is legal and gaining popularity in the UK, and although it is illegal in developed markets like the U.S (considered a form of gambling), a trader can bet on the US markets and a wide variety of U.S trading securities.

Financial Spread Betting Strategies

More often than not, betting or investing without a strategy leads to more losses than to profits. Similarly, with financial spread betting it is better to study the market and adopt a strategy before plunging in. Some of the most popular and effective strategies for traders are trend trading, breakout trading, news trading and range trading; and one can trade in trends by following them or triggering trades when a trend reverses.

1) Trend Following

The most common strategy used by traders – especially new traders – is trend following. The strategy involves looking at the momentum of the security to predict potential future direction of the trend and its optimal entry points. Price is said to be trending upwards if charts show higher highs and higher lows. Many traders see this as a bullish trend and assume a buy position. Conversely, if the downtrend shows lower highs and lower lows, traders choose to enter a short position. 

2) Reversal trading

In reversal (or contrarian) trading, the strategy involves looking for potential areas where trends are over-extended and ready to reverse. The idea is to go long when a downtrend reaches a support level and is ready to reverse or go short when an uptrend is reversing after reaching a resistance level. 

3) Range trading

This strategy involves identifying support and resistance levels and take a long position at the support level and a short position at the resistance level. New traders may prefer this strategy because it is easy to place stop-loss orders beyond the resistance and support price level depending on the position taken. In this example, a trader could take a long position near the support price 16,000-16,500 and try to close the trade as close as the resistance level as possible. A similar strategy with a short position would be optimal for a trader looking to go short, entering a short position at around 19,500 - 20,000 and closing as close as possible towards the 16,000-16,500 support levels. Note when the range is broken, new resistance and support levels usually develop and the current levels are considered not valid.

4) Breakout trading

Breakout trading is alternative to the above methods; it is a type of continuation strategy where prices are expected to extend higher or lower in case of uptrends and downtrends. The trader enters a buy position if the resistance level is broken, as it is considered a signal that the uptrend will remain in place. The same also applies in case a downtrend breaks the support level. The main advantage of this type of strategy is that the support and resistance triggers would aid to the continuation of the trend and are likely optimal places for entry points. In the example below, assuming the support level is 15,800, an investor could enter a short position when the price goes below 15,800 and bet that the direction of the price continues this path.  

5) News trading

This strategy, unlike previous ones, does not rely on technical analysis. It requires an understanding of macro-economic data and interpretation of news, economic policy, financial results and other releases. This form of trading is highly profitable because the price activity is often dictated by data releases or positive/negative news headlines.  

The Bottom Line

Financial spread betting is legalized in UK as a form of betting – although it is regulated as a financial product by Financial Services Authority. It is an effective way to generate enormous tax free profits with little investment needed. However, it entails a lot of risks – in some cases unlimited – for the investor and as such, the investor should understand and evaluate the risks before getting into any positions. Before entering into financial spead betting it is recommended to study the markets diligently and establish a well defined strategy.