Spread betting is not for the faint of heart, particularly in the fast-moving currency market. But it does provide plenty of opportunity for the savvy investor, and comes with some important advantages.
For one, investors aren’t required to buy any asset. Instead, they are speculating, or betting, on the movement of an underlying security.
The difference between a bid – the (lower) price at which you can sell, and the ask – the (higher) price at which you can buy, is the spread. That’s where making a prediction comes in.
Currencies are quoted in pairs such as EUR/USD, so a broker might quote the spread on that currency pair at 1.1002 and 1.1005, for example. If you think the first named currency – the Euro – is going to appreciate versus the second named currency – the U.S. Dollar – you place buy spread bet on EUR/USD. If you believe the opposite will happen, you can place a sell spread bet.
By doing so, you are staking a certain dollar value (say $10) per every pip (basis point) move in the currency pair. The pip, or percentage in point, is the smallest price move an exchange rate can make. For most pairs, the spread is determined by currency movements of 0.0001, except for the USD/JPY, which is traded at every 0.01 move.
Keep in mind that currency movements are often very small in a given day. However, since prices are constantly moving, the opportunity to make or lose money is always there.
Global currency markets are very liquid, with more than US$5-trillion traded on average each day. As a result, many brokers offer foreign exchange spread betting in larger currency pairs like Euro/Pound, USD/Japanese Yen, and other “majors” like the Swiss Franc, Canadian Dollar, Australian Dollar and New Zealand Dollar. Investors can also choose forex spread betting on more exotic currency pairs such as USD/Swedish Krona or USD/South African Rand, but these can be more volatile.
In addition to being more liquid than other markets, there are often tighter spreads and lower trading fees in forex spread betting.
Brokers also usually allow investors to use leverage, or borrowed money, to place these bets, making a deposit just a fraction of the full amount invested. For example, leverage of 100 to 1, would allow an investor to put up $100 and take $10,000 worth of currency positions.
If your losses appear to be heading above that margin, your broker will likely ask for more money to be added to your account. That’s why investors should consider the use of stop losses, which automatically closes out a trade when a security reaches a certain price.
Forex spread betting is usually a short-term trade, and spot market (current price) currency trades, which offer smaller spreads, should be closed out before the end of a day to prevent rollover charges. However, investors also have the option to bet on the value of a currency on a specific date in the future.
As with all types of currency trading, watching movements in price charts is critical and technical indicators are very useful tools. Currency markets are also highly sensitive to actions by global central banks and geopolitics, so investors should also keep their eyes on related developments there.