Unsurprisingly, there are many ways to trade the FX market besides the popular spot version. After all, currencies are the largest financial market in the world. A type of trading which may be unfamiliar to some is forex spread betting.
You might be going, “Huh, what is that?!” Spread betting forex is a tax-free, wager-like method of speculating in currencies that is primarily available only in the United Kingdom and Ireland.
Let’s look at how currency betting works in more detail.
What is forex spread betting?
Traders simply bet a certain amount of money per point, whether that particular market will be lower than the bid or higher than the ask.
It’s worth noting that spread betting forex doesn’t mean trading spreads (check out this guide looking at the forex spread definition). Of course, the spread in the context of financial trading is the difference between the bid and ask prices.
Yet, the spread in the spread betting currencies comes from the concept of the ‘point spread’ in sports gambling. Here, the point spread represents the margin of loss or victory for a particular sporting event. In forex, it is merely betting on price movements.
Spread betting forex shares many stylistic traits with conventional FX:
Spreads and swaps apply
The spread is a built-in trading cost for every traded pair in forex. As previously mentioned, a broker always presents two prices, the bid (or buy) and ask (or sell) prices. The spread is between the two.
Each position you make while spread betting forex has to go beyond the spread before it shows a profit. As with ordinary FX, traders look for markets with the narrowest spread because it decreases the overall transaction cost and shows gains faster.
It’s not only spreads that apply but swaps too. This is interest you pay or are paid (depending on the interest rate differential between currencies) for keeping a leveraged trade overnight. Scalpers and day traders shouldn’t worry about this charge.
It’s a derivative
Spread betting on forex is a form of derivative. This means that the price is derived from real currencies, whose values fluctuate based on global supply and demand forces. As with any derivative, you don’t own the underlying asset (in this case, the currencies).
Instead, the broker settles the loss or profit difference between your orders’ opening and closing prices. This is why a derivative is often called a CFD or contract for difference. However, there are still a few distinctions here when spread betting forex.
Also, you can hold your position indefinitely, provided you have enough margin. Yet, some brokers additionally offer expiry dates in the form of futures (check out our guide looking at forex vs futures here).
Use of margin
Like any derivative, spread betting currencies involves the use of leverage or margin. This mechanism allows you to open far larger positions with a relatively small balance. The aim is to magnify your potential gains without needing the bigger capital of an unleveraged trade.
Of course, leverage while spread betting forex can also amplify your losses if not used responsibly. So, it can be risky.
The main difference, though, is that leverage in spread betting is expressed as a percentage rather than a ratio (more on this later).
As with other derivatives, you can speculate in bullish (buying or ‘going long) and bearish (selling or ‘going short) markets. This is only possible when you are trading real currencies with leverage.
Difference between forex trading and spread betting
Let’s now cover the distinctions of spread betting forex.
Tax and stamp duty-free
The most attractive element of forex spread betting is that no taxes and stamp duties apply. The reason is that the UK government classes this trading style as speculative or gambling, which is naturally tax-free in the region.
On the other hand, traditional forex trading is more of an investment and comes with capital gains tax in most countries.
Therefore, spread betting currencies in the UK means you can keep virtually all your profits without worrying about the taxman.
Only the spread and swap apply when you are spread betting forex markets. You may be charged a small commission with ordinary FX brokers in addition to the spread and swap.
Different value, quoting, positional and margin calculations
In standard FX, we quantify monetary values according to pips. However, it is different with spread betting currency markets, where you measure based on British pounds per point (pp). Some times, it may be a penny or a hundredth of a penny.
Secondly, the price is quoted differently regarding the decimal place. In normal circumstances, the decimal goes after the whole number, e.g., 1.26330. Yet, when spread betting forex, the decimal would go before the last digit, i.e., 12633.0. So, how do we read points?
For instance, if the price went from 12633.0 to 12663.5, this would be a 30.5 point difference.
The next notable difference is how we express positions. For the latter, we refer to it as a lot size, while we call it a bet size in the latter.
Lastly, margin is expressed as a percentage rather than a ratio. The image below shows the common conversions between the two as a guide.
Here is the formula for calculating the ratio from a percentage:
1 ÷ percentage X 100
E.g., 25% is 4:1 = 1 ÷ 25 X 100
The average margin rate or factor with spread betting forex brokers is 3.33% or 1:30. We should note that leverage in forex for UK clients is quite limited compared to other countries in typical FX.
So, how much leverage is 3.33%? All you need to do is multiply this by the price of your spreadbet forex position and pound per point. For instance, if the quote was 15000 and you were trading £1 pp, you would need £499.50 (3.33 X 15000 X 1 ÷ 100) in your account.
The full value of this position is £15000. But, due to leverage, only a small deposit (3.3% of the figure) is necessary.
How spread betting forex works
Let’s now look at a practical example of taking a bet on currencies. Imagine betting that the EUR/USD was going to fall in price. So, you decide to sell it at 11912.6 at £15 pp, with a 3.33% margin factor.
The total value for this trade is £178 689 (11912.6 X 15). But with the 3.33% margin rate, you would only need £5950.34 (11912.6 X 15 X 3.33 ÷ 100) in your account.
Let us consider the two outcomes of this trade.
Say the euro fell from 11912.6 to 11890.4. This would represent a 22.2 point difference (by subtracting the two prices). At £15 pp, your profit here is £333.
What if the price went against you, where EUR/USD rose from 11912.6 to 11936.0? This would represent a 23.4 variance. At £15 pp, your loss here is £351.
As stated earlier, spread betting forex is available only in the United Kingdom and Ireland. This undoubtedly excludes a vast majority of the global trader population. If you are lucky to be a citizen of either country, then forex spread betting is something to consider.