Spread Betting

The concept of spread betting can be difficult to grasp, but once people understand it they don’t tend to forget it. Spread betting can be applied almost anywhere and that’s what makes it so versatile.

Imagine a scenario where two people notice several planes flying overhead. A simple question could get a spread bet started, such as ‘how many planes do you think we’ll see in the next hour?’ with a response of ’50 to 55’.

This can be turned into a spread quote of 50-55 and trading is ready to commence. One person has made the quote and the other person can decide if they want to trade. The quote is 50-55 so if the person thinks there will be more than 55 he nominates higher, if he thinks there will be fewer than 50 he chooses lower and if he thinks the quote is about right or doesn’t really care, then he does nothing and carries on watching the world go by. If he trades, he nominates a stake per plane. In this instance, the total number after an hour will be used to calculate the profit or loss.

Note that if he nominates higher then he is buying at the top end of the quote (55) and if he nominates lower he is selling at the bottom end of the quote (50).

Imagine he buys at 55 (top end of quote) and they agree a stake of £1 per plane. Remember, it is not simply a case of him wanting there to be more than 55 planes. He wants to see as many as possible. The more planes there are, the more he will make on the trade. Conversely, the fewer there are, the more he will lose. For each plane that he sees over the magical number of 55 he will make £1 per plane, so if they see 57 he will make £2, if they see 67 he makes £12. However, fewer than 55 and he loses £1 for each number under 55, so if the result is 40 then he will lose £15.

A spread company will make its prices available to a much wider audience but consider this. If only two people traded this hypothetical plane market and one of them chose higher at 55 for £1 a plane and one chose lower for £1 a plane at 50, then the spread firm would lock in a £5 profit whatever the outcome.

Spread firms trade prices in running and keep updating their quotes. Often you may be able to trade out of a position taking a profit if it has gone well or aiming to cut a loss if it hasn’t. This suits a spread firm as they make money from the spreads they quote. So, if you trade a market to close a position you are paying more spread to come out of the market.

What works well about spread betting is that the quote can be updated as you go along. Imagine the scenario where someone has bought at 55 for £1 per plane. In the first 10 minutes a total of 15 planes fly over and he asks for an updated quote. The person making the quote decides the best thing to do is to take the number from the first 10 minutes (15), multiply it by 6 to give a full hour’s expectation and put a spread round it. He therefore thinks there will be 90 planes and makes a quote of 87.5-92.5. Note that it doesn’t matter that the quote isn’t solely integers. They are playing for £1 a plane and all it means is that the settlement figure will be some pounds and fifty pence.

Having bought at 55 the person is happy because the high position can be closed by taking a low position to counter the original trade.  They can now go low at 87.5 (selling at the low end of the quote), having chosen to go high at 55 (top end of the quote) originally, giving a profit of £32.50 (87.50-55). The person making the quote thought there would be 90 planes and if that turned out to be the case and the other person had kept their position open and let it run to a conclusion, the settlement would have been 90 and the profit £35 (90-55). Although it’s reassuring to close a position at a profit it does mean paying a spread for the privilege.

Every trade needs to be played as much as possible on merit. Opening a position is 1 trade and closing a position is 1 trade. Sometimes the value from the opening trade can be swallowed up because a profit is available but profit doesn’t automatically make it the right decision.

It’s a lot easier to close a trade for a profit than it for a loss. Profit suggests that you know what you’re doing and loss is ugly. We shut out a winning position rather than a losing position because of the feelgood factor. It’s hard to close out a losing position because there is no feelgood in sight. It’s often shrewd damage limitation yet most people are likely to run a losing position to conclusion in the hope that it will turn around. This applies to spread and odds betting and is a gambler’s curse. Because we want something to happen we can still convince ourselves that it will.

That’s not the only curse. Lose a bet and it’s a downer, have a winner and it’s still a downer because you should have staked more. Emotions get in the way!