The Concept Of Financial Spread Betting In Detail
Spread betting is a leveraged financial product that acts as a derivatives market for investors to make profits by betting on the price fluctuations in the markets. The term ‘spread’ is coined from the difference in price quotes known as the ‘bid/ask’ or ‘bid/offer’ of an underlying financial asset. Spread betting is purely a speculative market, and the investor does not own the financial assets that he is trading.
Spread betting has been a part of the financial markets since the early 1970’s and is one of the most popular investment channels in the UK. The UK is considered to be the largest market for spread betting due to relaxed regulatory guidelines and a lack of capital gains tax on all profits accrued through spread betting. The UK has legalized spread betting by offering investors the option of saving on capital gains tax as well as stamp duty on all financial transactions performed through spread betting.
Spread betting allows investors to start trading using a moderate amount of money, especially due to the amount of margin and leverage available to the traders. While the substantial leverage can magnify the potential returns, trades in the opposite direction of the movement of an asset can also lead to significant losses.
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What Is Spread Betting?
Spread betting is the process of speculating on the price of a financial asset by betting on the direction of the markets to make profits. Spread betting consists of a wide range of financial instruments that range from stocks, commodities, indices, CFDs, currencies, and thousands of other financial as well as derivatives products. A trader can choose an underlying financial asset according to his preferences and then speculate the direction of the trend to place a trade either as a buy or as a sell signal.
To understand the working mechanism of spread betting in detail, we can consider the hypothetical price of a stock named “COMPANY ABC” to be at $300 per share. A trader speculates the price of the “COMPANY ABC” to rise shortly due to some strong company financials or news releases that are favorable for the stock. Therefore, the trader approaches a spread betting broker to place a trade and receives a quote of “bid at $299.00” and “ask at $301.00”. The difference in price of ‘bid’ and ‘ask’ is known as the spread, which is $2 for this particular stock.
Since the trader expects the price to move up, he places a buy order at the asking price of $301.00 and waits for the trade to develop. If the trader is proved right in his analysis, the stock will move up. Let us consider that the stock moves up to $311.00 within the next few hours, and the trader decides to close out the trade at profits. The profit on such a trade is calculated according to the points moved, which in this case is 10 points. Each stock has a nominal dollar value assigned per point that is directly related to the investment capital, and for this particular stock, we can consider the nominal value to be $10 per point. Therefore, the overall profit for this trade is $10 X 10 points = $100.
On the contrary, let us consider that the stock plummeted during the next few trading sessions by disproving the trader’s analysis. Let us consider that the stock moved down by 20 points to $281, and the trader has decided to close the trade resulting in a net loss of $200($10 X 20 points). This is how spread betting works in a never ending cycle of buys or sells until the trader makes sufficient gains or loses money in the markets.
How Is Online Spread Betting Different To Forex, Stocks, Or Binary Trading?
Spread betting is not entirely different to Forex trading, as the only difference is that spread betting is tax-free in the UK, while Forex trading is not. Forex trading is also an accepted form of financial markets around the world without any exception while spread betting is legal only in certain countries such as the UK.
On the other hand, spread betting has distinctive differences between stock trading and binary trading. In stock trading, a trader owns the underlying stock by entering into a contract with the broker and the exchange. When an investor buys or sells a stock, he can have an impact on the underlying value of the stock that is proportionate to his investment capital. The investor can also receive dividends on the shares that he owns and can enjoy a much better freedom and flexibility over his trades. In spread betting, a trader has no right over a financial asset as he does not own the stock and is merely speculating the direction of the property according to his analysis.
Binary options are purely speculative markets that depend only on the direction of the movement of a financial asset and does not allow the trader to profit or lose on every points change. Binary options are simple buying and selling markets that work on a fixed profit and loss model for each trade. The profit potential for binary options is severely limited to the payouts percentage, while in spread betting, the trader has more control over how much he gains or losses per trade according to the pip movement.
How Can You Find The Best Spread Betting Platform?
The popularity of spread betting in the UK has led to a significant rise in the number of spread betting brokers in the UK that offer different platforms to carry out trades. Spread betting is similar to Forex trading by incurring spreads, commissions, and SWAPs for overnight trades. Several companies in the UK cater to traders from around the world for spread betting, but the legality of spread betting is doubtful in several countries. Unlike Forex trading that is an accepted form of financial markets internationally; spread betting is subject to the approval of the respective Governments.
It is easy to sign up for a demo account at some of the established spread betting brokers in the UK or other parts of the world and get a first-hand experience of how spread-betting works using a virtual trading environment. A trader can sign up to different brokers and test out their platforms to find the best trading platform that suits their requirements and trading preferences. Ultimately, the ease of use and the convenience of a spread betting platform are determined by the trading personality of a trader and the essential tools required to make a thorough analysis of the markets.
Different Types & Components Of Spread Betting Shares
Spread betting incorporates a broad range of financial instruments from across the globe. Most spread betting platforms offer the convenience of trading stocks, indices, currencies, CFDs, ETFs and other instruments from several stock exchanges including the US, Europe, and Asia. Since spread betting does not involve the actual transaction of stock between an exchange and the trader, spread betting brokers are not required by law to be connected to an exchange to carry out the financial transactions. All spread betting orders are filled by the broker as the process of carrying out trades is purely on a speculative basis and the trader is only betting on the price of a financial asset. However, all spread betting companies are required to be registered with intermediary banks and liquidity providers to ensure that the price feed of all financial assets is accurate according to the existing market conditions.
What Are The Tax Implications Of Financial Betting?
Financial spread betting is exempted from capital gains tax as well as stamp duties in the UK, which has helped several traders to enjoy a tax-free status on all transactions performed through a spread betting broker. Most traders based out of the UK extend their portfolios to spread betting to enjoy the tax advantages and mitigate the risks in other financial markets. However, it should be noted that different countries may tax income received from spread betting, and the UK is the only known country that offers tax benefits under such a trading instrument.
The tax benefits of spread betting are only extended to the residents of UK. Even UK citizens who reside abroad are subject to rules applicable to spread betting as per foreign laws, and might even be barred from carrying out such transactions if the host country has deemed spread betting to be illegal.
The Legitimacy Of Spread Betting In US & Other Countries
Spread betting is banned entirely in countries such as US, Japan, and Australia. The primary concern of these nations is that spread betting resembles gambling in a lot of ways, but fails to realize that spread betting has more in common with Forex trading than binary options. However, we see that most countries accept binary options as a valid form of investment, which resembles gambling more than spread betting. There are several theories doing rounds as to why spread betting is not legalized in the US, but as of now, traders in the US, as well as several other nations, are restricted from indulging in any activities related to spread betting.
Can You Lose More Than You Deposit In Spread Betting?
Perhaps the biggest difference between spread betting and other forms of financial trading is that a trader can lose more money in the markets than they have deposited with the broker. This will result in a negative balance, and the trader will owe money to the broker. The massive leverage available in spread betting along with the volatility of the markets is the culprit for such an event.
Spread betting should be chosen with absolute care and precaution by fully understanding the potential risks involved in the industry. Several brokers try to put a protective mechanism in place to avoid negative balances, but if a trade is not managed according to proper money management principles, a trader can still achieve negative balances that the broker is then entitled to recover from their client.
Trading on margin is not safe for a trader who fails to adhere to proper risk management. A trader might be considered to be a good analyst, but all the market analysis will be in vain if a trader is unable to get out of losing trades at the right time. In spread betting, the amount of risk is magnified due to the high leverage and immense volatility of the markets.
Is Online Spread Betting Suitable For All Investors?
A trader should indulge in spread betting only if it is legal in their country of residence. There are several attractive benefits of spread betting that can excite a trader, but it is essential for investors to learn about all the risks involved in spread betting before putting their hard-earned money on the line. All traders should make use of a demo trading account and achieve consistent results before switching over to a live account with a real deposit. Demo trading is as important in spread betting as in all other financial markets across the world.
For the right trader, spread betting can prove to be a hugely profitable investment, especially considering the fact that the trader can make hefty gains using a small initial capital. Spread betting also allows a trader to diversify his investment portfolio and gain better returns over a short period, which is impossible in traditional methods of stock trading. A trader is also not required to hold on to their investments for a longer period to enjoy the same returns that can be had while trading stocks or indices.
How To Reduce The Risk In Spread Betting
It is possible to mitigate the risk in spread betting by being proactive in analyzing the markets and using good money management strategies. However, for traders who are new to the financial markets, it would be a good idea to invest in a signals service that can send the right calls to help traders to read market conditions better. Signals also allow a trader to validate their findings and ensure better entry and exit of trades to ensure long-term profitability. Several high-quality signals providers can also help traders to decrease their drawdowns by making the right calls at the right time.
What Are The Different Time Frames & Costs Involved In Online Spread Betting
Spread betting is similar to Forex trading as far as timeframes and costs of trading are concerned. Most brokers offer the option of choosing a daily funded trade or long-term trades according to a trader’s preferences. Every trade will incur a spread, which is the initial cost of spread betting. All overnight trades are also associated with SWAPs, and some brokers are also known to charge commissions per trade. Traders can choose to keep their trades open for as long as they desire, but losing trades are mostly closed out during a margin call or when the trader’s balance turns negative.
Will We See Spread Betting Being Legalized In The US Soon?
It is difficult to predict whether the US will legalize spread betting anytime soon. However, there is hope as the NFA and CFTC have opened up to the idea of binary options trading recently, which used to be a banned market during the early days of binary options trading. Therefore, traders can be rest assured that spread betting might be considered as a valid financial market in the long run.
Spread betting is indeed a great option for traders who wish to pursue excitement in trading and generate huge returns in the process. However, the risky nature of spread betting and the questionable legality of the market in several countries severely limit the number of traders that can trade successfully in the markets. Spread betting is not guaranteed to be more profitable than Forex trading, but traders from the UK can take advantage of the fact that spread betting is exempt from capital gains tax or stamp duties, which will reduce the operational costs of trading in the financial markets. Several Forex traders in the UK are also ditching Forex trading for spread betting as these two markets are broadly similar to each other, but with the added advantage of saving on taxes and other transaction costs.