In certain jurisdictions traders have the ability to speculate on currency fluctuations using a range of financial derivatives. Financial Spread betting allows individuals to speculate price fluctuations without owning the underlying asset. Unlike fixed odds betting, spread betting allows for a range of outcomes with the bet regarding whether the outcome will be below or above the spread. Financial spread betting is particularly popular in the United Kingdom where the activity is regulated by the countries Financial Conduct Authority rather than the gambling commission. It is important to note that spread betting carries a significant amount of risk and can result in gains and losses far in excess of the original stake wagered.
An Example of a Forex Spread bet
If an individual had a hunch that the price of the EUR/USD was going to rise, they would get a quote for the pairing. The institution offering them the bet would quote a spread and in our example our imaginary trader is quoted 1.3523 – 1.3525. They then decide to take a position in the EUR/USD by placing a £1 per point buy/long bet. In this particular instance the price of the EUR/USD rose to 1.3528 with the trader ultimately closing the position for a total profit of £3 (£1 x (1.3528 – 1.3525)). Obviously the market can move against you as well which would see our imaginary trader losing £1 for each pip the market moved against them. Spread betting is seen as very risky as it is possible to lose far in excess of what you originally deposited in your account and may not be suitable for everyone. The way a spreadbet works isn’t too dissimilar to how trading normally works and those who have experience with traditional trading should be able to get to grips with spreadbetting relatively quickly.
Spread betting vs. Spot Forex
By far the most popular way to speculate on the currency markets is to trade the markets directly with Spot FX brokerage; however the vast majority of spread betting firms and a number of Forex brokerages offer currency spread betting to their customers. There is no definite answer to which option is preferable with both forms of trading having their own pros and cons.
Spread betting is particularly attractive to residents of Britain and Ireland, as profits from spread betting are currently tax free. This is due to the fact that tax authorities have deemed financial spread betting to be gambling, with gambling profits being exempt from tax. This means that the majority of UK spread bettors do not pay any tax on their profits unless they rely on spread betting as their only source of income. However the tax situation in these countries may change which would certainly dampen the interest in financial spread betting.
People have also been attracted to financial spread betting as certain spread betting companies tend to offer tighter or fixed spreads on currency pairings. This is due to the fact that no underlying asset is being traded which leads to smaller transaction costs, it is not uncommon for UK spread betting firms to offer a 1 pip spread on major currency pairings during the London trading session. While these tight spreads may be very attractive, spread betting firms act as the counter party to customers trading activity. This means that spread betting firms typically profit when customers lose and take a loss when the customer turns a profit, which presents a potential conflict of interest. The reason why STP/ECN Forex brokerages are so popular is that such a model aligns the interests of the brokerage and the client.
Risks associated with Spread Betting
As with all forms of financial speculation spread betting involves significant risk. It has been argued that spread betting is particularly risky and there seems to be some evidence to back that up. In 2009 a study by Britains Gambling Commission found that almost 15% of spread bettors developed a serious gambling problem, while only 1% of those who partook in other forms of gambling developed a serious gambling problem. Another study this time undertaken by CASS Business School found that only 1 in 5 spread bettors ending up making money, however this corresponds to the ratio of retail traders who end up ahead. Whether spread betting is inherently more risky than other forms of trading is debatable put individuals should be aware of the risks before getting involved with financial spread betting.
Financial Spread betting is just one way in which retail traders can speculate on the currency markets, with many traders being attracted to spread betting due to tight spreads and the fact that profits from spread betting are tax free in certain jurisdictions. As with all forms of trading there are substantial risks and if you are unsure whether spread betting is for you, it is advised that you seek advice from an independent adviser.