Spread betting can yield high profits, if the bets are placed correctly. (Related: What Is Spread Betting?) Most successful spread betting traders follow a systematic trading plan created through sufficient experience and knowledge. The icing on the cake comes from spread betting profits being tax-free in countries such as the UK.
Yet, only a small percentage of spread bettors are successful. Why does a majority fail, and only a few succeed? Investopedia looks at the following important points for success and profitability for spread betting.
Spread betting is illegal in the US, although it is legal and very popular in European countries, particularly in the UK.
Trading Tighter Spread Securities
Assume a stock is trading at 300 pence. But due to its illiquid nature, a wider bid and ask spread of 290–310 pence is available (see Bid-Ask Spread definition). With a bullish view, one can buy at 310. Once in, in order to profit he needs to find a buyer who can purchase at a much higher price. If the stock makes a 3.33% jump from the current 300 to 310, it is still a no-profit scenario for the trader due to wider spreads.
Instead, if there is a similar priced but highly liquid stock trading at 300 pence and with a tighter spread of 298–302, then buying at 302 and closing at 310 will offer significant gains. Spread betting on tight spread instruments improves the profitability significantly.
Building a Structured Trading Plan
How much total trading capital is available? How much money will be used per spread bet? How frequently will spread bets be placed? Answers to such questions help create an efficient trading plan. Having GBP 50,000 and blowing away GBP 25,000 on a first bet will leave you at a significant loss. With the remaining GBP 25,000, you need to gain 100% profit just to recover your lost money. The profitability of spread betting can be improved substantially when one enters with a clearly-defined spread betting plan, which is based on total capital, bet amount per sequential bet, and frequency of placing the bets.
Structuring the Bet Entry and Exit
On an average, Ami makes 4 winning trades out of 5, while Ben makes 1 winning trade out of 5. Whose trades are more profitable?
The common answer will be Ami, but it may be incorrect. Structuring the bets properly can allow one to be profitable in the long run even with a lower number of winning trades.
With GBP 10 per winning bet, GBP 50 per losing bet and 4/5 = 80% success rate, Ami effectively makes (0.8*GBP 10–0.2*GBP 50) = –GBP 2 loss.
With GBP 50 per winning bet, GBP 10 per losing bet and 1/5 = 20% success rate, Ben effectively makes (0.2*GBP 50–0.8*GBP 10) = +GBP 2 profit.
The key to the game is placing the bets right, with the right amount depending upon success percentage. Losing small multiple times and gaining big a lesser number of times can compensate for any losses, if trades are structured properly.
Right Market and Right Instrument Selection
A UK-based spread betting firm like CityIndex offers spread betting across 12,000 established global markets, with asset classes including stocks, indices, forex, commodities, metals, bonds, options, interest rates, and sectors.
Most novices tend to simultaneously play around in multiple markets and securities without a clear understanding. One should build expertise in a few asset classes. Attempting to generalize will lead to mounting losses.
Prepare, Plan, and Practice Before Entry
Most spread betting firms offer a free practice demo account with virtual currency. Learn the tricks of the trade, backtest the structured betting plan, and practice it multiple times before jumping in with real money. Markets will remain forever, but real money lost during an initial phase of ignorant and inexperienced attempts will be difficult to recover.
Once comfortable with virtual returns, enter with real money but start small and then expand as the betting profits increase.
Controlled Use of Leverage
Spread betting is available on leverage, which magnifies profit (and loss) exposure despite limited capital. With GBP 100, a 10% leverage margin can allow one to make bets for up to GBP 1,000, while a 1% margin allows exposure up to GBP 10,000. Leverage is a double-edged sword—it magnifies the profits when a bet works favorably, but also the losses if it goes wrong. Successful spread bettors use leverage efficiently with tight controls to their benefits, while novices get tempted to take large positions and end up losing more than they have. Controlling the leverage usage, based on realistic availability of the capital amount, is necessary for success in spread betting.
Factor in the Tax Benefits
While devising a trading plan, or while comparing performance from different trading activities, it is important to factor in the tax benefits available in spread betting. This is a very significant factor to making genuine profits.
The Bottom Line
Spread betting, though illegal in the U.S., is very popular in the U.K. and European countries. It offers high profit potential, but most traders lose out during the initial entry phase due to ignorance and inexperience. (Related: What are the biggest risks involved with financial spread betting?) Building sufficient knowledge, selecting the right instruments to spread bet, and practicing and backtesting the system based on the outlined points can assist in generating profits from spread betting.