Spread-betting refers to a trading strategy wherein one takes advantage of the quick execution of trade orders on a number of financial instruments. Also known as leverage trading, it allows investors to make profits off the differences in prices of assets without any actual ownership.
This trading strategy has gotten so popular that brokers have offered access to global financial markets and virtually any type of asset class, be it stocks, commodities, forex or futures for customers to trade. Not only does it allow a client to maximize his funds with greater buying power for greater potential returns, but it also offers a way to avoid taxes on profits.
How does spread betting work?
A trader can bet on the price direction by placing a long order when he believes that it will go up or a short order if he believes it will go down. The profit or loss is the difference in prices during which the trader opened and closed the trade, multiplied by the number of units risked. This position size is pre-determined by the trader, depending on how much of his account he’s willing to put on the line.
For example, if you choose to bet £1 per point on Apple stock, you will win £1 for every point Apple moves higher. And you will lose £1 for every point that Apple falls. Thus, it’s easy to see how big amounts can be won or lost in just a short time with spread betting.
What is scalping?
Scalping also refers to a type of trading strategy based on the time frame for which a trader keeps positions open. Scalpers or day traders generally close their positions in just a few hours or by the end of the day, locking in gains or losses from quick price action instead of staying in longer-term trends.
There are also various types of scalping methods, some of which take advantage of volatile price moves during a news event or economic release and others base entries and exits on inflection points or psychological levels. One needs to be able to make quick decisions with this approach or be able to watch several positions open at the same time.
Slippage and Stop-Hunting
A particularly challenging aspect of spread betting scalping is slippage, which involves the widening of the bid-ask spread during volatile market situations. In these cases, trades might not be executed at the exact price specified but a few points or pips away. Because of that, a scalper has to wait for price to move significantly in his trade’s favor before finally catching a profit.
Some say that trading firms or brokers monitor the short-term orders being placed ahead of news events to rip off spread-betting scalpers, but this doesn’t always hold true. However, there have been instances when computers or algorithms are able to trace where large positions are placed before widening the bid-ask spread enough to hit the stops instantly in a process known as stop-hunting.
Of course stop-hunting might prove to be more costly for a firm or broker to attempt on a regular basis, as this also involves putting up a large amount of cash to front the trades and try to rip off their clients with buy or sell stop orders in place.
Another potential risk to spread-betting scalping, especially for those who are new to the financial markets, is that you can lose your capital quickly when you don’t manage your risk properly and get a margin call. In fact, one can lose more than the amount deposited, but this depends on the terms of your broker.
Pros of Spread-Betting
Spread-betting is typically the entry point of beginner traders, as it doesn’t require a complex understanding of financial instruments and ownership of assets. It is also less complicated compared to trading futures, options, and other derivatives.
Also, depending on your broker, spread-betting trading isn’t accompanied by commission costs. Brokers make profits from the bid-ask spread so there is no need to add transaction fees per trade. You can trade different financial markets round-the-clock without having to worry about conversion costs in playing a foreign index or stock.
Another advantage of spread-betting trading is that you can diversify your portfolio and hedge your positions. You can have a long position on USD/CAD while shorting the S&P 500 index or buying crude oil futures so that you can profit whenever any of your trades move in your favor.
Of course any type of trading does come with risks, apart from the fact that you can lose the money you deposited in your account and more. Some of these risks are more associated with the broker you trade with so it’s important to open a demo account first or read the firm’s terms and conditions to make sure that you have a good understanding of the risks involved.
Also, your trading instruments can also come with some type of risk, as charts or price updates can be delayed, thereby affecting your trade decisions especially when you’re trying to scalp or catch quick price moves. Trade execution can also be subject to delays from time to time, preventing you from entering or exiting trades at the exact price you desire. This can also be dependent on your internet connection or your computer speed.
Experts say that spread-betting is more suitable for short-term to medium-term trading, as this is halfway between scalping and longer-term investing. With the former, there’s always the risk that price moves aren’t sustained or are quickly reversed in the same day. With the latter, the costs of keeping positions open for days or weeks can accumulate and wind up eating up most of your gains on the actual position.
Either way, technical analysis plays a strong role in spread-betting strategies, as these can help a trader figure out the best entries and exits to catch the majority of his predicted price move. Fundamental analysis can also help to some extent, particularly when playing a top-tier news report and trying to catch the initial price reaction, but this can be more appropriate for longer-term swing positions.
In any case, it’s best to identify which type of trading suits you based on your preferences and personality, as the high stakes involved in spread-betting scalping are not for the faint-hearted.
For the most part, scalping is a strategy you probably want to avoid when using a spread betting platform as the margin for error is very small. There are plenty of much more profitable strategies to get involved in such as end-of-day trading or swing trading.
If you do choose to look into spread betting, just remember to stay clear of some of the white label outfits, of which there are many.
The only spread bettor we recommend is IG Index, a UK-based firm which have been around for many years.