Truth be told, spread betting is a risky business. It is not for the faint of heart. However, there is an upside to it. If you have hunches on how currencies will turn out in relation to the happenings in the macro environment, then spread betting is a good way to make money by backing up the hunch with cold cash. If your hunches are proven to be right, then you can certainly make a lot of money.
What Does It Mean?
Spread betting is simply the speculation of whether or not the prices of a certain asset will increase or decrease. You can make bets on almost anything. It can range from share prices, to commodity prices even to indices of the stock market. The catch is that you need not buy the asset that you are betting on. You just take a position on the given price being offered by the spread betting company of whether or not the prices will increase or decrease.
How Does It Work?
A company engaged in spread betting will be offering the bettor a quote. The quote would consist of a bid or selling prices and an offer or buying price. For instance, the FTSE 200 is currently at 5800, the firm would then lay down a bid price of perhaps 5795 and also an offer price of 5802.
If your hunch is that this index would increase then you might want to “buy” at the given offer price for £10 per point at 5802. Thus for every point that the FTSE increase, your earnings you can gain £10 each. Take for example the FTSE increases to 5822, then the profit is computed through the following (5822-5802=20 X£10). Thus, profit is at £200. In contrast if your hunch is that the FTSE will decrease then you could “sell” at 5795.
However, spread betting is not all roses. You cannot always expect to win. While it is true that you can gain a lot even with just a small investment, you could also lose a lot.
Since there is the possibility of losing a lot when things go wrong, the firms engaged in spread betting would demand a form of protection that gives them assurance that you can settle. Thus, there would be a form of deposit, which is called a margin. The rule of thumb is that the margin would be ten percent of the bet’s value. Thus, if the losses have the tendency to be more than that margin already, then the firm would demand additional amount of money. This is what is known as a margin call. If the bettor is not able to raise the amount for the margin call then the firm could close the position now based on the current pricing.
The downside of margin calls in controlling losses is that you could lose money fast. Another alternative is to use stop loss. This is an order to close the trade at specific price level. But then again there could be problems even with a stop loss because of the fast movement of the market; you cannot be assured that the deal closes at the expected price level.