What is the difference between spread betting and forex trading?
Foreign exchange is a vital part of today’s interconnected global economy. Companies require foreign exchange for paying for goods in another currency and dealing with international employees. People require it whenever they are travelling abroad, paying for their child’s education or paying mortgage for real estate overseas. This guide is designed to help investors and individuals understand the basic differences between spread betting and forex.
Understanding Forex Trading
Traditional forex trading in simple terms is selling a particular currency and getting another currency in exchange, as per the existing exchange rate between those two currencies. For example, a trader will sell GBP£ 100 to get approximately US$ 140 at a rate of 1GBP=1.4USD. If the price of the held currency rises, in this case USD, the trader can make a profit by selling the USD. The difference between the buying and selling rate is the trader’s profit. There is no universal exchange, so most of the transactions are made over the counter, where individual buy and sell transactions are matched. Once a deal is finalised, known as a spot deal, there is an exchange of the currencies between the two parties.
Understanding Financial Spread Betting
Spread betting is different from the traditional forex trading in various ways. In spread betting, there is no actual exchange of the currency or purchase of the financial instrument that is being traded. Spread betting involves taking a position based on anticipating whether the price of a financial instrument will increase or decrease in the future. This form of betting means an investor will win or lose money based on the marginal variation of a particular outcome and the expected value spread quoted by the spread betting brokerage. Besides foreign exchange, spread betting can be conducted on a wide range of financial instruments, including interest rates, individual share prices, indices, price of commodities etc. Depending on how a trader expects the market to move, he/she can either put in a ‘Long Buy’ (anticipating a rise in price) or a ‘Short Sell’ (anticipating a fall in price). Spread betting is further illustrated by these examples:
Case 1: The trader expects the price of the financial product to rise. The trader assumes that the GBP to USD exchange rate will increase, assuming the exchange rate is 1GBP=1.14USD. The trader places a bet of £20 for every 0.1-point rise in the exchange rate. (long position). With this, there will be two possible outcomes:
- If the exchange rate increases from $1.14 to 1.70 (a 0.56-point rise), then the trader’s profit will be 56 X 20, which is £1120.
- If the exchange rate fell from $1.14 to 1.02 (a 0.12-point fall), then the trader’s loss would be 12 X 20, which is £240.
Case 2: The trader expects the price of the financial product to fall. The trader assumes that the GBP to USD exchange rate will decrease, assuming the exchange rate is 1GBP=1.14USD. The trader places a bet for £20 for every 0.1-point fall in the exchange rate. (short position). There will be two possible outcomes:
- If the exchange rate increases from $1.14 to 1.70 (a 0.56-point rise), then the trader’s loss would be 56 X 20, which is £1120.
- If the exchange rate fell from $1.14 to 1.02 (a 0.12-point fall), then the trader’s profit would be 12 X 20, which is £240.
The profit or the loss with respect to spread betting depends on two things.
- The stake size, which is the amount an investor bets for every point increase.
- The points drop or gain of the underlying financial product, which the investor has put his/her money in.
What Are The Pros And Cons Of Both Investments?
Investors should be aware of the pros and cons of both investments before making any financial decisions:
- The biggest advantage of spread betting is that none of the profits are taxed. Forex trading is not tax-free, as you have to pay capital gains tax, as well as stamp duty.
- In spread betting, you need to put in only a fraction of the money you trade. This is known as margin trading. This means traders can trade in high value since they have to put down only a fraction of this price as the initial stake, if the price moves in the way desired by the trader the profit can be much more that in forex trading. However, the inverse is also true. The loss can be significantly higher as opposed to forex trading, if the movement in price is opposite to what is desired by the traders. In traditional forex trading, the trader has to put down the entire amount of the trade, so the profit or loss is limited to the amount the trader has put down in the trade
- Forex trading being a long established industry is regulated to a higher extent, as compared to spread betting. Traditional forex trading is provided by more established brokerages or financial institutions such as banks that provide accounts in multiple currencies. Because of this it is always best practice when choosing a spread betting provider to always consider going with a regulated brokerage.It is important to note that because spread betting involves high leverage the potential of losses from spread betting can be enlarged.
Best Forex And Spread Betting Providers
Traders and individuals that want to trade forex, binary options and spread betting will benefit from working with a long established and trusted broker like ETX Capital. If you would like more information on ETX Capital, read our full review of ETX Capital here.
If you would like to see the best spread brokers available, read our comparison of spread betting brokers.
Traders and individuals should keep in mind that their capital is at risk when they make any investments.