Many investors wonder how financial spread betting companies make money when they don’t charge brokerage fees on bets placed. IG Group Holdings, a spread betting company in the United Kingdom, reported £569 million from global trading revenue in the 2018 financial year. But how do companies like IG actually generate a profit? And how does a trader select the right broker?
The following is a look at how spread betting and how financial spread betting companies create revenue.
Basics of Spread Betting
Spread betting is a lot like gambling in that an investor speculates which way security prices will move. Rather than buying or selling (or owning) the asset, the investor will try to guess whether its price will move up or down during a certain period of time based on the buy and sell prices offered by a broker. So, as an investor, you make your bet on whether you think the price will rise or fall. The more it moves, the more profitable it is for the investor, and, therefore, for the spread betting company.
One thing to keep in mind: Financial spread betting is illegal in the United States. It is, however, legal in the United Kingdom.
Revenue From the Spread
First and foremost, spread-betting companies make revenue through the spreads they charge clients to trade. In addition to the usual market spread, the broker typically adds a small margin, meaning a stock normally quoted at $100 to buy and $101 to sell, may be quoted at $99 to sell and $102 to buy in a spread bet. The buy price is always higher than the sell price, ensuring the broker makes a profit from the spread, whether the client wins or loses.
The A Book and the B Book
Brokers categorize clients into two separate categories or their A or B books. Traders who have a track record of losing money are placed into the broker's B book. Bets from B-book clients are not sent to the market. Instead, the company actively bets against them. In this scenario, the broker stands to win when the client loses and vice versa. Given that 90% of traders lose their deposits within six months, this model has proven to be extremely profitable.
There is, however, some risk involved with backing B-book clients. Spread-betting companies have risk limits, and if too many clients bet in one direction, these limits are breached. Brokers must then hedge their bets to restore risk to an acceptable level. Brokers avoid hedging B-book clients unless absolutely necessary because they are effectively paying for another spread, therefore increasing bottom line costs.
A-book clients are a similarly dependable stream of revenue and provide opportunities to capture commissions. They trade enough that risk is substantially lower than B-book clients, and they often enjoy a relationship in which they are trusted to expose the market (and not the broker) to risk. Such clients are often charged a premium on the standard spread, or a specially negotiated fee.
But IG Group says it doesn't profit off the backs of its clients — especially those who are unsuccessful in their trades. According to its website, the firm says its clients mainly offset each others' positions, so when one client buys one lot of a security, another one sells another lot, which covers both sides. Since there is no exposure to either client's profit or loss, IG says it makes its money off that spread.
Associated Trading Costs
Spread-betting companies allow their clients to continue trading throughout the global trading day, Monday to Friday from the time the Asian session opens to the time the New York session closes. The flipside is that spread-betting companies typically charge a holding fee to carry a position overnight.
Beginners often get distracted by an attractive spread and miss these ongoing trading costs, which in time, are likely to erode profits. It is therefore in the best interests of the broker to keep clients holding positions as long as possible, as they stand to generate more revenue from associated fees.
Spread-betting companies are subject to strict regulations worldwide. The European Securities and Markets Authority (ESMA), for example, passed and enforced regulations that limit certain types of financial betting. In late 2018, ESMA upheld a ban on the sale of binary options to retail customers, which may change some investors' interest in spread-betting companies.
Finding the Right Broker
Spread-betting companies obviously make a lot of money, but how can a beginner get involved? The first step is choosing the right broker, sometimes a misstep for overeager traders who often squander their initial deposits. The markets may move against a trader, but more often than not, it is the choice of broker that determines overall success. Does the client bet on commodities or interest rates? How important is customer support? Which broker has the lowest spreads? These are important concerns when considering which spread-betting company to choose.
The other thing to consider, especially if you're new to the game, is a broker that offers a demo account. This allows you to practice how to spread bet without the stress of losing money.
Spread Betting Companies
There are a number of different companies that allow investors to open up accounts and begin spread betting. Here are a few of them:
IG Group: Founded in 1974 solely as a spread betting business, IG Group is based in the United Kingdom. The firm now provides investors with other services including online forex and share trading. IG Group also offers demo accounts to new clients.
InterTrader: This company was founded in 2011 and is owned by a publicly traded gaming company called GVC Holdings. The company says it has a conflict-free policy in that it doesn't act as a counterparty to investors' trades. Along with spread betting, the company offers forex and contract for difference (CFD) trading. InterTrader promises new investors a risk-free spread betting environment with its demo account.
ETX Capital: ETX Capital was founded in London in 1965. The firm's areas of specialty include spread betting, forex, options, commodity, equity, and bond trading.
New investors can sign up for a demo account to practice their trading strategies before jumping in.
The Bottom Line
Taking advantage of online spread-betting comparison resources, using price comparison tools and keeping a level head means that a trader can feasibly share in the wealth that spread-betting companies have created. But knowing how companies work and choosing the right one for you is crucial if you're going to succeed. Make sure you do your research before you commit to a platform.