What is spread betting? The rules explained

So, how does spread betting work? When financial betting in the UK, you don't buy or sell the underlying instrument (for example a physical share or raw material). Instead, you place a bet on a derivative based on whether you expect the price of the underlying instrument to go up or down.

If you expect the value of an asset to rise, you may open a long position (buy). Conversely, if you expect the asset to fall in value, you may take a short position (sell). You will make a profit or loss based on whether or not the market moves in your chosen direction.

With the product, you buy or sell a predetermined amount per point of movement for the instrument you are trading (for example, £1 per point). This is known as your 'stake' size. The bigger the stake, the greater your exposure will be for your chosen asset.

This means that for every point that the price of the instrument moves in your favour, you will gain multiples of your stake times the number of points by which the instrument price has moved. On the other hand, you will lose multiples of your stake for every point the price moves against you. Please note that losses are based on the full value of the position.

See our spread betting examples​ for more information.

The difference between the buy (bid) price and sell (ask) price is referred to as the spread in trading. This is where a broker's commission is made, as the buy price will be slightly higher and the sell price slightly lower than the underlying market's price.

Trading spreads are implemented by market makers, brokers and other providers to add costs to a trading opportunity, based on supply and demand. Depending on how expensive, volatile and liquid an asset is, the spread will fluctuate along with its price and trading volume.

The spread of an instrument is a representation of how closely aligned the supply and demand are. If the bid-ask spread is very low, there is a common consensus on an asset’s price, whereas if there are some disparities between buyers’ and sellers’ opinions on an asset’s worth, the spread is generally wider.

Say for example, Apple stock is trading for a buy (bid) price of 141.10 and a sell (offer) price of 141.14, the spread would be 4.

Derivatives are a type of leveraged product, which means you only need to deposit a small percentage of the full value of the trade in order to open a position (also called margin trading​). While margin (or leveraged) trading allows you to magnify your returns, losses will also be magnified as they are based on the full value of the position.

As an example, common margin rates for indices start at 5%. This means that you only have to deposit 5% of the asset's full value in order to open a position, allowing you to trade with 20x leverage. This is equivalent to a 20:1 leverage ratio.

Leverage and adverse price movements lead to an increased risk of rapid capital loss.

Many investors choose this method when trading on the financial markets as there are advantages of spread betting over buying physical assets, such as the following:

A spread betting strategy is a predetermined plan that helps you to define your market entry and exit points and any accompanying risk-management conditions such as stop-losses. When utilising a trading plan as part of your wider trading strategy, you aim to create a process in which you can monitor and look to potentially forecast trade outcomes.

When trading with a financial betting account, it may be good practice to outline and follow your own trading strategy template relative to your needs. Templates help to define a set of rules you should follow for every trade, helping to remove emotions and irrational responses from your trading strategy. This keeps consistency within your trades and can help improve your trading mindset. Below are two simple example of strategies that traders may use.

This strategy involves opening a long position (placing a buy bet) if you think that the value of your chosen asset will increase. By buying at a lower price, if your prediction is correct and the asset does increase in value, you can then sell for a higher price. This will result in a profit, although if your prediction is incorrect and the market moves in the other direction, this would result in equal losses.

This takes the opposite approach of a buy-and-hold strategy. If you think that the asset’s value is due to fall in price, you can take a short position and place a sell bet. By selling at a higher price, you can then buy the asset back at a lower price once it has dropped, making a profit from the difference in value.

Shorting is a very risky strategy, so consider researching how the markets work and apply any risk-management tools before opening a trade in order to cap losses to a minimum.

It's a good idea to keep up to date with current affairs and news because real-world events often influence market prices. As an example, let's look at the UK government’s help to buy housing scheme.

Many believed that this scheme would boost UK home builders' profitability. Let's say you agreed and decided to place a buy bet on Barratt Developments at £10 per point just before the market closed.

Let's say that Barratt Developments was trading at 255 / 256 (where 255 is the sell price and 256 is the buy price). In this example, the spread is 1.

Let's assume that you opened a long position at £10 per point because you thought the price of Barratt Developments would go up. For every point that Barratt’s share price moved up or down, you would have netted a profit or loss multiplied by your stake amount.

Let's say your prediction was correct and Barratt Development stock then rose to 306 / 307. You decide to close your buy bet by selling at 306 (the current sell price).

The price has moved 50 points (306 sell price – 256 initial buy price) in your favour. Multiply this by your stake of £10 to calculate your profit, which is £500.

Unfortunately, your prediction was wrong and the price of Barratt Development stock dropped over the next month to 206 / 207. You feel that the price is likely to continue dropping, so to limit your losses you decide to sell at 206 (the current sell price) to close the bet.

The price has moved 50 points (256 – 206) against you. Multiply this by your stake of £10 to calculate your loss, which is £500.

Every trader utilises different methods and strategies to suit their trading style. There are, however, some common tips a trader can utilise in order to maximise their trading potential: