Spread betting can yield high profits if the bets are placed correctly. Most spread betting traders are successful only after creating a systematic trading plan following years of experience. Only a small percentage succeed and the majority fail. We look at the important factors for success and profitability for spread betting.
NOTE: Although popular in Europe and particularly in the United Kingdom, spread betting is illegal in the United States. The Commodity Futures Trading Commission prohibits the sale of foreign security futures products to retail investors based in the U.S.
Trading Tighter Spread Securities
Assume a stock is trading at 300 pence. But due to its illiquid nature, the bid-ask spread is wide at 290–310 pence. Because of the wide spread, a buyer who pays 310 pence for their position doesn't make a profit even if the stock jumps 3.33% to 310 pence.
Now take a similarly priced but highly liquid stock. Its spread is tighter at 298–302 pence. A buyer who pays 302 pence for the position will profit after a smaller move. Betting on instruments with tight spreads improves the potential for profits 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 £50,000 and blowing £25,000 on a first bet will leave you at a significant loss. With the remaining £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 Entry and Exit
Structuring bets properly can allow one to be profitable in the long run, even if your losing trades outnumber your winning trades. Consider Ami, who on average wins 4 of every 5 bets, while Ben only wins 1 of every 5 bets. Whose trades are more profitable?
On the surface, the answer would seem to be Ami, but it depends on bet sizing and the risk-reward scenario.
- Ami wins 4 of every 5 bets for an 80% success rate. She nets £10 per winning bet, but gives up £50 per losing bet. Ami effectively makes (80% x £10) – (20% x £50) = £2 loss.
- Ben wins 1 of every 5 bets for a 20% success rate. He nets £50 per winning bet and gives up £10 per losing bet. Ben effectively makes (20% x £50) – (80% x £10) = £2 profit.
The key is placing bets in the right size given the risk versus potential reward. Losing multiple small bets for the chance of a single big win can pay off if trades are structured properly.
Right Market and Right Instrument Selection
A UK-based spread betting firm like CityIndex offers spread betting across 45 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. 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. 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 £100, a 10% leverage margin can allow one to make bets for up to £1,000. Leverage is a double-edged sword. It magnifies profits when a bet works favorably, but also the losses if it goes wrong.
Successful spread bettors use leverage efficiently with tight controls, while novices get tempted to take large positions and end up blowing their accounts. Controlling the leverage usage, based on a 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 in 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 potential for high profits, but most traders when they start due to inexperience. Building sufficient knowledge, selecting the right instruments, and practicing and backtesting a trading system can assist in generating profits from spread betting.