Spread Betting In Forex Markets

In the Forex market arena, a trader has a variety of instruments that they can use at their discretion.  While many Forex traders use forwards, futures and options, many enjoy spread betting on Forex.

What is a Forex spread bet?

Forex is known to be a highly leveraged derivative, with the underlying asset consisting of the respective currency pair. Spread betting in the forex markets is similar to other forms of spread betting and involves placing a bet on the expected direction the underlying currency pair is expected to move. Trades using spread bets are normally carried out over-the-counter (OTC), through the medium of a financial spread betting broker.

How does a Forex spread bet work?

The trader must first find an appropriate broker which will typically  provide the trader with two quotes.  These will be the bid and the ask for the currency pair. The difference between the two quotes is called the spread. 

If the trader expects the currency pair to rise, then he can enter into a long (buy) position.  Conversely, if he expects the currency pair to fall, he will enter into a short (sell) position.

The payoff the trader receives will be dependent upon whether the currency pair moves below or above the bid price and ask price, along with the position that he has bet on.

Spread betting on Forex is a highly leveraged method of trading, where a bet in the right direction will yield compounded profits and returns.   Having said that, the same applies to a movement in the wrong direction can lead to severe loss.

Therefore, it is extremely important that the trader is well aware of the risks involved prior to entering this speculative arena and opening their first trade.

An example of a spread betting on forex trade is as follows:

The broker quotes the following: The EUR/USD pair has a bid price of 1.3500 and an ask price of 1.3510.  The trader can either bet that the price will rise above 1.3510 or fall below 1.3500. If he chooses to go long and bets $1 for every pip that the pair rises above 1.3510 and then the price rises to 1.3520, he will make a profit of $10. However, if it falls to 1.3500, he would lose $10.

Risks of Forex Spread betting

Financial spread betting, in general, is a very risky product as it makes use of high leverages resulting in a magnification of profits or losses. In addition to this, forex markets are inherently volatile and have to be tracked on a regular basis. The combined effect makes spread betting in forex extremely risky. The trader must ensure that he is aware of these risks before trading. He must also ensure that he takes measures to protect himself from excessive losses.

Some of the steps that can help reduce these risks are:

Developing a trading plan: Developing a concrete trading plan and sticking to it helps to protect against volatility. It also helps to define clearly and understand the trading objective.

Understanding the market: It is also important to understand and analyze the market which is being traded. The forex market is extremely complex and requires tracking of multiple factors.

Monitoring positions: Once the trade has been entered into, monitoring of the open positions is equally important.

Maintain a strict stop loss: It is equally important to maintain a strict stop loss while trading in the forex markets. A stop loss helps the trader to protect himself against any adverse market movements thereby safeguarding his interests.

Lastly, a key factor when spread betting is that you are trading in dollars per point, pounds per point, etc., which can help the trader pre-determine his potential risk factors and/or profits.