Spread betting and binary options trading are very similar in concept. Both involve making predictions on price movements. Both also involve trading financial instruments based upon the price movements of their underlying assets. And neither type of trading requires you to actually own the asset on which a given trade is based.
But there are also notable differences between spread betting and binary options. We’ll get into those differences in the space below. First, we’ll cover the basics of spread betting and explain how experienced traders limit their losses and lock in their profits. We’ll then compare spread betting with binary options, highlighting some of the ways in which they differ. If you’ve been thinking about getting involved with spread betting, what you’re about to read is likely to prove valuable.
Spread Betting 101: How Spread Betting Works
Spreads are commonly used in sports betting. When a game or match is held between a favorite and an underdog, a point spread is used to create a market on both sides. Otherwise, everyone would simply bet with the favorite. The spread ensures that half of the bettors back the underdog. Thus, a market can be created very easily around nearly any event.
Spread betting works similarly in the financial markets. Here, the spread reflects the difference between a “bid” and “offer” price (or buy and sell price) presented for a given asset. If you believe the asset’s real-time market price is going to drop below the bid, you could “sell” the asset in anticipation of the drop. Conversely, if you think the price is going to rise above the offer, you could “buy” the asset. Your profit or loss is determined by the number of points the price moves.
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Let’s look at a quick example…
Suppose you want to participate in spread betting on shares of Google. The stock has a bid of 695 and an offer of 705. Let’s further suppose you believe the price is going to fall below 695. So you “sell” the shares (keep in mind, you don’t actually own the underlying asset), wagering $2 for each point in the price’s movement.
If Google’s share price falls below 695 as you expect, you’ll profit $2 for each point. For example, if it falls to 690, you’ll profit $10. If it falls to 650, you’ll profit $90. It’s up to you when to close the contract and take your profit.
However, suppose Google’s price moves in the opposite direction. Instead of falling below 695, it rises to 702, then 705, and then 710. Here, your loss equals $2 for each point above the bid (i.e. 695). If you close the contract at 702, you’ll lose $14. At 705, you’ll lose $20. And at 710, you’ll lose $30. Again, you choose when to close it out.
Those are the basics to spread betting in the financial markets. You may be thinking, “If I predict the price movement of an asset correctly, I can make a huge profit without even buying the asset.” That’s true. However, it’s worth noting that you might also suffer a major loss if your prediction turns out to be wrong.
Limiting Your Losses And Locking In Your Profits
Trading platforms that accommodate spread betting allow you to set stop loss orders to limit your losses. A stop loss essentially closes the trade when the price of the underlying asset reaches a certain point.
Let’s use our earlier Google example to see how this works. Suppose you wager $2 a point that Google’s share price will fall below the bid of 695. Instead, the price begins to climb with no sign that it will turn around. If you’re watching the trade, you could simply close the contract, thereby limiting your losses. If you’re not watching it, the price could continue to climb indefinitely, expanding your losses in the process.
One way to protect yourself is to submit a stop loss order. It causes your position to automatically close, putting a cap on your losses. For example, you could enter a stop loss at 710, limiting your losses to $30.
Another useful tool is the limit order. Limit orders are used by traders to lock in profits on their trades. Suppose in our earlier example that the share price of Google did indeed fall below 695. It continues to drop, expanding your profit. A limit order can automatically close the trade once the price falls to a certain level.
So, why would you want to close your position early in a profitable trade? In reality, you haven’t earned a profit until the contract has been closed. If Google’s share price turns around and starts to rise, your unrealized profits could be wiped out. Even worse, you might sustain a loss if the price rises far enough. A limit order locks in your profit and prevents such a scenario from occurring.
Spread Betting Versus Binary Options
Recall from earlier that we said spread betting was similar to trading binary options. And so it is for the reasons already mentioned. But the differences between the two types of trading are arguably more important since they can have a direct impact on your profits and losses.
With binary options, you know how much you stand to win or lose before you execute a given trade. Your potential profit is posted as a percentage of your investment amount. Your potential loss is equal to the amount you have chosen to invest. This is much different than spread betting, where your potential profit or loss on the trade is essentially unknown and unlimited.
Binary options trading can be extremely profitable with small movements in the price of a contract’s underlying asset. For example, an “up or down” binary option is profitable or unprofitable based on whether the asset’s price moves up or down, not on how far the price moves. You’re not wagering a certain number of dollars per point. You’re engaging in an “all or nothing” trade.
Because you don’t need to predict the extent to which an asset’s price will move while trading binaries, your predictions don’t need to be as accurate. To win, it is much easier to say the price of Google’s stock will rise than to predict it will rise by a certain number of points.
Lastly, trading binary options is simple. A complete novice can get started within minutes. Of course, this is not to suggest you should jump in without having a trading strategy in mind. http://www.binarytrading.org/strategy/ offers trade strategies. Rather, you don’t need to learn complex formulas or perform in-depth analysis to start making profitable trades.
So which is the better form of trading: binary options or spread betting? You’re the only person who can make that decision. Having said that, trading binary options tends to be simpler and there is less uncertainty about profits and losses.
Risks, Rewards, And Bankroll Management
Profitable binary options trading and spread betting isn’t just about making correct predictions on price movements. It also involves understanding the relationship between risk and reward and the importance of properly managing your capital.
First, it should be clear that there is a significant degree of risk involved with both forms of trading. The opportunity to make 70%, 80%, or even 100% on your investment is rarely unaccompanied by risk. In other words, you can lose money. Even experienced traders make lousy calls that result in losses. It happens to everyone. The key is to minimize your risk, which brings us to our second point…
Don’t invest a huge portion of your capital into a single trade. Keep each investment to less than 5% of your base. That way, if a binary option ends out of the money, or a spread bet runs the wrong way, you can bounce back easily.
One of the worst things you can do while trading binary options or spread betting is to chase your losses. That’s a recipe for financial disaster. Instead, if a contract ends poorly, cut your losses and take whatever lesson you can from the experience.
How To Get Started With Binary Options
Getting started with binary options is very simple. The most challenging part is finding legitimate brokers, a task we’ve all but handled for you on this site (see our complete list of the top binary options brokers). Once you’ve selected two or three companies that seem trustworthy and efficient, register an account with each of them and make your first deposit. You’ll be allowed to trade binary contracts as soon as your deposits hit your accounts.
It’s a good idea to learn how to read candlestick charts. They’ll help you to make profitable decisions regarding the price movements of the assets you choose to follow. Although the charts may seem intimidating at first glance, they are very easy to understand. Moreover, with time, you’ll start to gain a “sixth sense” for how certain markets and assets behave.
Whether you participate in spread betting or binary options trading, it is critical that you understand the risks involved. There is no guarantee that you’ll earn a consistent profit. Having said that, you can drastically improve your trading results by properly managing your bankroll, learning to read candlestick charts, and being receptive to lessons as you gain experience.