What it means
In a spread bet, the provider quotes two prices, a lower sell price and a higher buy price, and the gap between them is the spread. You bet that the market will finish above the buy price (going long) or below the sell price (going short), and the spread is the main cost of the bet.
Your stake is expressed as an amount per point. For most currency pairs, a point is a pip, the smallest standard price move, so a stake of $5 per pip earns $5 for each pip the market moves in your favour and loses $5 for each pip against you.
Spread bets are leveraged, meaning that you only put up a small deposit, called margin, to control a much larger position. This magnifies both gains and losses, and a loss can exceed the money in your account unless the provider offers guaranteed stops or negative balance protection.
Positions can be rolling daily bets, which are kept open as long as you like at a financing charge, or fixed-expiry bets that end on a set date. Stop-loss orders are essential, and guaranteed stops, where offered, ensure that the position closes at the chosen level even in a fast market, usually for a small extra fee.
The tax and regulatory treatment is a major reason for its popularity in the UK. For many individuals, gains are generally free of capital gains tax and stamp duty, but the treatment depends on personal circumstances and can change, so it should be checked with a tax adviser.
Regulators in several countries have tightened rules on leveraged products, with limits on leverage and mandatory risk warnings. Statistics published by providers consistently show that a large share of retail clients lose money, and that is a point to weigh seriously.
In practice
Real-world examples.
Example
A trader in London expects the pound to rise after a central bank announcement. She places a $10 per pip long bet on GBP/USD, adds a stop-loss 30 pips below, and closes the bet for a gain when the target is reached.
Example
A first-time bettor opens a bet of $20 per pip on a volatile pair and does not set a stop. A sudden 80-pip move against him produces a loss of 80 x $20 = $1,600, which is far more than he expected to lose.
Example
A part-time investor holds a daily rolling bet for three weeks. The financing charges, taken each night, slowly erode the profit, and she realises that the bet was better suited to a shorter holding period.
Formula
Calculation
Profit or loss = (closing price - opening price) in points x stake per point
Spread cost = spread in points x stake per point
Suppose a trader buys EUR/USD at 1.1002 (the buy price) with a stake of $5 per pip, and the market later moves so that the sell price is 1.1042 when she closes. The movement is (1.1042 - 1.1002) / 0.0001 = 40 pips.
The profit is 40 x $5 = $200. If the spread was 1.5 pips, the cost of crossing the spread was 1.5 x $5 = $7.50, which is already reflected in the buy and sell prices used. If the market had instead fallen 40 pips, the loss would also be $200.Case study
Seen in the real world.
Marlowe Wealth is an illustrative, fictional educational website that follows a group of beginners who each deposit $1,000 into spread betting accounts. The group agrees to risk no more than 1% of its balance on any single bet.
Over six months, the participants who stuck to the rule survived longer than those who increased their stake after wins. Two participants who ignored the rule lost most of their deposit in a few days when a surprise announcement moved the market sharply.
The illustrative conclusion was that position sizing mattered more than predicting direction. Participants who kept the stake small could be wrong many times and still have capital to continue.
Watch out
Common mistakes.
- Choosing a stake per point without working out the dollar loss if the price moves by a normal daily range.
- Trading without a stop-loss, when a fast market can generate losses far beyond the initial deposit.
- Ignoring financing charges on positions held for many days, when these charges accumulate each night.
Questions
People also ask.
Is spread betting the same as trading currencies?
Not quite, because you never own the currency, you only bet on its price movement, and the contract is with the provider.
Can I lose more than I deposit?
Yes in some cases, because losses can exceed the deposit unless the provider offers negative balance protection, so read the terms carefully.
Why is the spread important?
It is the main cost of every bet, and the price has to move beyond the spread before you are in profit.
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