This series of articles will take you through a short course on financial spread betting, and will help you to evaluate whether you should be using financial spread bets in the first place, helping you to identify the opportunities and the potential pitfalls.
Spread betting explained
Before deciding whether to open a financial spread betting account it is important to understand what a financial spread bet really is – a derivative contract that changes in value depending on movement in the underlying market. A typical example would be a spread bet based on the FTSE 100 index.
If you buy a financial spread bet you do not own the underlying asset. The price of a financial spread bet could be based on a share price, a stock market index (like the FTSE 100) or even a commodity future, like Brent Crude Oil.
Financial spread bets are OTC derivatives
A financial spread bet is also an ‘over the counter’ product of OTC derivative in financial parlance. This means that you are not trading it on an exchange, where there are thousands of buyers and sellers. A financial spread bet is not a share. It is a contract that exists between you and a broker. It is a bilateral deal. Nobody else can buy your bet from you – you can only ‘sell’ it back to the broker.
A financial spread bet goes up and down in value, largely in line with the price of the underlying asset. But be warned, there can be a discrepancy in the price you are being quoted by a broker and the price you may be seeing from an independent source, like Thomson Reuters. This is because the price you are trading is the price your broker is quoting to you.
Financial spread bets are only available in the UK and Republic of Ireland. You cannot trade them if you live outside these countries. Inside the UK and Ireland, they are tax free. They are popular with traders who want to exploit movements in markets over short time frames, sometimes with as little as an hour or a day between opening and closing a trade. Financial spread bets are not long term investment products.
Financial spread bets also come with a number of other key advantages:
- Control your risk: Financial spread bets allow you to control your risk by limiting the amount of money you bet on the change in price. For example, if you bet only £1 per point on the FTSE 100, you will make – or lose – less money than if you are betting £5 per point.
- Leverage: Leverage really means borrowing money to try to increase your profits. Financial spread bets are margin trading products. This means that you are borrowing money from your broker to turbo charge your trade. It means you can make more money than you would with a normal investment in something like a company share on the stock market, but get it wrong, and you stand to lose more money too.
- Trade different markets: Financial spread betting allows you to trade markets you cannot usually access otherwise, like forex, but most beginners start by trading the price of indexes like the FTSE 100 or S&P 500. This is advisable as not all markets are created equally, and some are simply more risk and volatile than others.
- No commission: Unlike with share trading, very few brokers now charge commission on financial spread bets. The actual cost of the trade is contained within the bid/offer spread, which is something we will look at more closely in this series.
Check out the next in this series on financial spread betting, when we look in more depth at the different types of financial spread bets.