Spread Trading (or Spread Betting) is a way of trading the financial markets without ever having to purchase stocks or shares.
Traditional investment in shares involved calling up your stock broker or opening up an online share dealing account and buying x number of shares at a certain price. You owned these shares personally and you held them until such time as you were ready to sell them (hopefully at a higher price than you bought them at). You paid the broker who you bought the shares through a commission, assuming you sold the shares for a higher price then you bought them you paid capital gains tax (currently 25%) on any profits you made. Owning the shares also entitled you to a dividend for every share you owned (assuming the company you bought the shares in was in a position to pay a dividend) and you were also entitled to attend and vote at the company’s AGM.
Spread Trading on the other hand works differently. Firstly, you never actually take ownership of the shares you open a trade on. Instead you effectively open a bet on the future movement of the stock in question. This allows you go either go long (bet that the share price will go up) or go short (bet that the share price will go down) when you open a spread trade. There are many benefits to spread trading but this is probably one of the most useful, the idea that you can bet on shares going down. In midst of todays global financial crisis, the option to bet on share prices falling and make money if that turns out to be the case is a huge advantage.
When you open a spread trade you need to decide whether you are going to Buy (go Long) or Sell (go Short). You then need to decide what stake per tick (or point) movement you are going to put on. A tick or point is the smallest amount that the price of a share can move by, typically the equivalent of a one cent (or one pence) movement in the share price. So for example, if CRH was trading at €17.00, that would translate to a price of 1700 on a spread trading website. If the share price moved up to €17.50, that would equate to 1750, or a 50 tick movement.
If you were long on CRH at a stake of €2 a tick, you would be up €100 following that 50 tick movement. If on the other hand you went short CRH at 1700 at a stake of €2 a tick, you were hoping the share price would fall, in the case where it rose to 1750 you would now be down €100.
So we have discussed going Long or Short and the stake per tick, next up is the spread (what gives Spread Trading or Spread Betting it’s name). The spread is effectively the difference between the price you can go Long at and the price you can go Short at. It is always where the various spread trading companies make their profit. So if we were to go back to our earlier CRH example and make it a bit more accurate, if you wanted to trade CRH and it had a current share price of €17.00, then you could either go long at a price or 1710 or go short at a price of 1690. This 20 tick difference is what the spread trading company makes on your trade. So if you went long at 1710 at €2 a tick, you would immediately be down €40 (20 ticks x €2 per tick). You would need the CRH share price to rise 20 cent (to €17.20) to breakeven at which point the price offered by the spread trading company would be go long at 1730 and go short at 1710. For every cent that the CRH share price continues to rise, you would then be up €2. So if the share price continued to rise up to lets say €18.00, the spread would then be go long at 1810 and short at 1790. At this point you could close out your Long position in CRH. To do this you effectively sell (or go Short) CRH to close your position. So you would close your position by selling CRH at 1790. The difference between your closing price (1790) and your opening price (1710) is 80 ticks. At your initial stake of €2 per tick you would have made a profit of €160.
As always with Spread Trading the reverse is always true, lets say you went long at 1710 but instead of going up the CRH share price fell to $16.00. The spread would then be long at 1610 and short at 1590. In this case to close your position out you would need to sell CRH at 1590. The difference between your closing price (1590) and your opening price (1710) is 120 ticks. At your initial stake of €2 per tick you would have made a loss of €200 (Note: €40 of this was the initial spread).
Click here for some more examples of how spread trading works. All of the examples mentioned here relate to shares but it is worth noting you can also spread trade all the major indices (DOW, DAX, FTSE, ISEQ, etc), currencies (EUR, USD, GBP, etc), commodities (e.g. gold, silver, oil, wheat, etc), bonds and interest rates.
Earlier I mentioned how one of the advantages of Spread Trading is that you can go short as well as long. There are many other advantages that spread trading offers over traditional share investing. Click here to read up on them.
Before you get carried away with all the benefits make sure you read and fully understand the risks involved with spread trading. Click here to read up on them.
