Spread Betting

Financial Dictionary -> Investing -> Spread Betting

Financial spread betting stands for a leveraged tool which helps investors carry out transactions and speculate on the financial markets without purchasing the underlying instruments. Both, seasoned investors and novices can participate in a wide range of markets, including stock indices, individual equities, commodities, currencies, etc. However, spread betting is better suited for experienced investors who are well aware of the risks associated with gearing and margins. The bulk of spread betting comes in the form of volume-based short-term transactions, and traders come in and out of positions on a daily basis.

There is a similarity between spread betting and share trading. When an investor buys shares of a particular company, he or she believes that their price will rise. So, the purpose is profit making. Individuals who bet on the movement of share prices aim at precisely the same. The only difference is that shares cost more, compared to placing a bet.

The concept of spread betting was developed by Stuart Wheeler in a period of penal exchange controls (1970s). The goal was to help investors punt on the price of gold without purchasing bullion. Originally, spread betting was based on different financial barometers such as the Dow Jones and Financial Times. In 1983, City Index opened doors, and Spreadex, Cantor Index, and Financial Spreads followed suit.

With spread betting, investors can open a single account and take short or long positions, trading on various financial markets. Unlike CFDs and share dealing, whereby commission is paid for every transaction, here the difference between bids and offers stands for the commission. In other words, the wider the spread is, the more money the trader pays. Rather than buying shares, the investor makes a bid as to the direction in which the share price or market will move. The amount one wishes to bet is referred to as the 'stake'.

Investors make use of different strategies to place winning bets. Scalping aims at minimizing risk, and traders close positions quickly to take small gains. Another strategy is to trade on market trends when a news story or an announcement causes the markets to react. The trader identifies a starting price trend and decides on what position to adopt. Reversal trading makes use of graphical performance data to predict the point at which certain indices or markets will reverse, due to perceived under- or over-pricing. Upon analysis of market performance, it becomes clear where the lower and the upper limits of an index were over a recent period. When a share or market starts approaching the limits, this strategy advises on watching the index movement closely and pouncing at the first signs that there will be a reversal. Finally, trading break-outs involves positioning a stop loss at the upper limit in order to counter the effect of failed price break-outs. If the price of shares moves against the investor, the imposed stop loss limits the losses to a fixed amount. At the same time, there is no limit with regard to the amount the investor may win.

Financial spread betting is appealing to many investors due to the fact that profits are tax free in view of capital gains tax. On the downside, this financial instrument involves higher risk than share trading, as losses will not be offset against capital gains.