How Much Am I Trading In Spread Betting?

Published by Filipe R. Costa on Mon, 27/02/2012 - 15:58
money

Traders sometimes become a little confused when using spread betting to place their trades since they don’t figure out how the amounts really compare with traditional trading. A spread bet is defined in terms of stakes per point rather than quantities thus resulting in a confusion to the trader not used to it. This article explains how you can compare the amounts involved in a spread bet with traditional trading.

Traditional trading involves buying (or selling) a number of shares (or other asset) at a certain price. By multiplying quantity by price we get volume, or the total amount we’re trading. A simple example illustrates this. Let’s say we are willing to buy 10,000 shares of Lloyds at 35.7p. By multiplying price and quantity, we get the total amount we need to place the trade. In this case it totals £3,570.

In spread betting, instead of using quantities, we have to place a stake per point move. We don’t buy 10,000 shares but rather bet in price movement directly. We may bet £1, £10, or any other allowed amount. Some spread betting providers allow for stakes less than £1 and in fractions (Finspreads for example), others require a minimum of £1 and integers (Capital Spreads, Intertrader). It seems a little harsh to understand but it is not.

The spread betting firm quotes a spread that is usually more or less equal to the real market price for that asset. So, for Lloyds case, let’s assume the spread quotes 35.7. We then decide to place a stake of £100 per point at that quoted price. The notional amount of our position is exactly the same as in the case above, or £3,570.

If you multiply the quote by the size of your stake, you get the notional amount that corresponds to the full amount invested using traditional trading. Not convinced? Let’s deeply look at it.

If Lloyds rises 10% to 39.27p, you will have £3,927 in your account with your broker. By subtracting your initial investment from this amount you get your profit, which is £357 for this particular case. In spread betting, the new quote for Lloyds represents a gain of 3.57 points times your stake of £100, for a total of £357. This compares with the broker example. Are you convinced now?

Just to complement this example, let’s think on what happens if the stock ceases to exist or goes into bankruptcy, ending with a value equal to zero. This would represent your maximum loss, and thus it is your total investment. In the first case there is no doubt you would lose £3,927. In the second case, a value of zero represents a point change of 35.7. Multiplying this by your £100 stake, you will get the exact £3,570.

You can replicate your positions traded through traditional trading in a spread betting account. The key is to understand the ideas of notional amount, stake, and quote; and to understand how these figures compare with trading volume, quantity, and price. You can then get a whole new world of trading advantages spread betting has to offer over traditional trading if you master these basic features.

As a final comment I must mention that spread betting is not related to betting or gambling just because it has betting in the name. The difference between betting/gambling and investing/trading lies in your attitude towards risk rather than on a simple name.