Spread betting on forex has a number of differences to trading forex in the underlying market, mainly related to how prices are presented and the way you deal.
Scaled pricing
The prices you see when spread betting on forex may look very different to those used in the underlying market. That's because, in traditional trading, the participants physically trade one currency for another - so the price represents exactly how much one unit of the base currency will buy of the counter currency.
But when spread betting you are staking an amount of money per point, or pip, of movement in the market. Therefore, many providers scale their prices to make it easier for their clients to see what represents one pip.
The table below shows the difference between unscaled and scaled prices. Notice where the decimal point lies in each case:
In the spread betting examples a 1.0 movement represents one pip in every case, making it easier for bettors to monitor their positions.
These prices may look odd to traders used to traditional forex quotes. Looking at the table above, one euro clearly does not equal over 10,000 US dollars for example.
Price sourcing
Another major thing to note when spread betting on forex is where your provider gets their prices from.
Because forex is an over-the-counter (OTC) market, there's no central exchange for trading. Therefore, there are no standardised rates for forex transactions and no official values that spread betting providers can use for their own prices.
Instead, providers generally source prices from one of the major forex-trading banks (eg Barclays, Deutsche Bank, JPMorgan, UBS). Some even source them from a number of different banks, choosing the best buy and sell quotes from among them. The more banks that are used by your provider, the more competitive their forex prices are likely to be.
Forex spreads
Once your provider has the underlying rate, they will then add a spread on top to create their own prices. This spread is usually variable – mainly because the spread between the buy and sell prices in the underlying market is also variable – and so is liable to change throughout the trading day based on the volatility and liquidity of the underlying market.
For this reason, when advertising their forex prices, providers will often refer to a number of different terms, for example:
- Minimum spread - the tightest possible spread a provider will offer
- Typical spread - the standard dealing spread, used most of the time
- Average spread - the average spread over a given period of time
- Fixed spread - a spread that will not vary, usually applied over a specified period of time
- Capped spread - a spread that will vary, but only up to a predefined maximum
To keep things as simple as possible, most providers will generally only use two or three of the above. Here's how IG presents its forex spreads for some of the major pairs:
It's important to understand that the spread could get wider than the quoted typical spread in certain market conditions. If a forex pair is particularly liquid and unlikely to experience wild price swings, a provider will usually only add a small spread. As the market gets less liquid and more volatile, the spread tends to get wider.
When placing a spread bet, you'll want to find the tightest possible spread, because the tighter the spread, the less the market will have to move in your favour in order for your bet to become profitable. So it's important to consider when and in what conditions to enter and exit your positions on currency pairs, as wider spreads could have a significant effect on the profitability of your bets.
Impact of leverage
When you spread bet on forex, you'll need to put up a margin payment which may only be a small proportion of the value of the currency you're dealing on. Remember that your potential loss could be much greater than this, however.
Lesson summary
- Many providers scale their prices to make it clearer what represents one pip in the movement of the currency price
- Forex is an over-the-counter market, which means there's no single exchange from which your provider can get their prices
- Instead of standardised rates, providers source prices from one or more of the major forex-trading banks
- The more banks that are used by your provider, the more competitive their forex rates are likely to be
- The spread in forex is likely to vary throughout the day based on the volatility and liquidity of the market
- The less liquid and more volatile a market, the wider a spread tends to be
- When you spread bet on forex, you only need to put down a small deposit relative to the full value of the position
