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Description of spread trading along with examples.

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Only available in the UK and Ireland, spread trading is a financial derivative, meaning that traders can speculate on market movements to make a profit without owning any underlying assets. As traders will be using a percentage of their funds there are risks involved, so it can be important to understand the pros and cons of spread trading before starting it.

Key information about spread trading

Spread trading aims to select a security to ‘trade’ on and decide how much money you want to put on its potential to either rise or fall. This amount will be set per price movement and if the asset performs in the way you expect it to, the ticket will be successful. If it doesn’t however, and the price moves in the opposite direction, you will suffer a loss. The good news is that there are ways to minimize the risk factor, typically by setting stop-loss orders, which will automatically close the trade if things don’t work out how you’d like.

One of the key advantages of spread trading is that you can either sell short (trading on drops in price) or buy long (trading on price rises), so there is double the potential. If you still want to learn about what spread trading is, you can read more here.

A quick look at margin and stakes

As spread trading uses leverage, you’ll only need to place a small amount of your own money on the trade and this is known as the margin (this is typically only a small percentage of the total value of the position undertaken). The amount you stake can be important, as this is the price that outlines how much of the underlying asset you are hoping to trade and will affect the margin. Profits and losses are calculated by multiplying the stake amount per point in the movement. Here’s a basic example:

If you were to open a spread trading position on the FTSE 100 index for £1 per point, and the price is set at 5000, your margin deposit will be £250 (5%). That means you are getting £5,000 of total exposure to the underlying asset for that price.

Two spread betting examples

An example of selling short:

When short selling, the aim is to trade on (and profit from) the falling price of a security. In this case, the example is based on a GBP/USD currency pair.

At the beginning of the trade, you are quoted 1.23000 – 1.23008, so £1 is worth around $1.23 in the underlying spot forex market.

As the trade per price movement is 0.0001, a change from 1.23000 to 1.23010 is classed as a one-point move.

This looks attractive, so you want to sell £5 per point. The notional value of the trade would be £61,500 (12,300 points x £5). 

The margin required will be 3.33% with 30:1 leverage, so £2,048 is the deposit you will need to put forward for the trade ticket. 

Now would be the time to set a limit order to buy if the price falls to 1.22500. This means that when the spread your broker is quoting moves down to 1.22492-1.22500, the order gets filled and you earn £250 profit on the finalized trade.  

When selling short, a rise in the price of the underlying security is a bad thing. If the spread quoted had moved up to 1.23492-1.23500, the loss would be 50 points x your £5 stake and equal £250.

An example of going long:

You find security with a selling price of 11550 (£115.50) and a buy price of 11560 (£115.60). You believe that the shares in this asset are going to rise over the next few days. This encourages you to open a long position (buy) for £10 per point, at this price.

Your prediction turned out to be right, and you opted to close the trade when the market increased by 30 points and the selling price reached 11590. This means your profit is £300 (30 x £10).

If your speculation was wrong, however, and the price fell to 11,510, you’d have incurred a loss of £500 (50 x £10), as the market moved 50 points away from your bet.

Should you start spread betting?

Now you must have an understanding of what spread trading is and have some examples to go by, you may decide to get involved. If this is the case be sure to select a reputable broker, practice risk management and never trade more than you can afford. As these types of trades are leveraged, you run the risk of losing more than your initial margin, as both profits and losses are equated across the entire spread. With this in mind, it can be worthwhile to keep an eye on how things are performing, so you don’t get caught out with a larger loss than you’d expected. Utilize demo accounts and stop losses to protect yourself from this.

Disclaimer:

Spread trading and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread trading and/or trading CFDs. You should consider whether you understand how spread trading and CFDs work and whether you can afford to take the high risk of losing your money.

Marketing for CFDs and spread trading is not intended for US citizens as prohibited under US regulation.

Tax treatment depends on your circumstances. Tax law can change or may differ in a jurisdiction other than the UK.


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Source: Market Business News