Forex Spread Betting

See: Foreign Exchange.

If a horse named "Forex Spread" ever runs in the Kentucky Derby, this would be an easy one to define. For now, it relates to currency trading...and gets a little complex.

First, the "spread" in "forex spread betting." The term refers to the price difference between the bid and ask for an asset. A financial market works like an auction. Most of the action is run by computers on the backend, so casual investors might not notice the auction part. But for every stock price quoted on Google, there's a bid/ask system going on in the background.

Spread betting uses the gap between the bid and ask at any given time.

The "forex" part of "forex spread betting" refers to currency trading ("forex" standing for "foreign exchange"). The strategy uses the bid/ask spread in the price for a currency pair (Euro/U.S. Dollar, U.S. Dollar/Canadian Dollar, Euro/Pound, etc.).

Spread betting exists in a grey area between gambling and investing. The trader doesn't take a position in an asset (in this case a currency pair). They are simply betting whether the price will go higher or lower.

It's a lot closer to choosing red or black on a roulette wheel than it is to actual investing, as exemplified by, say, buying shares in Apple because you think its earnings prospects look good over the next 10 years.

A better parallel to spread betting might be a sports book, but one where you can make micro in-game wagers. Like betting whether the next pitch in a baseball game will be a ball or a strike, or betting on whether the next play in football will be a run or a pass.

The forex spread betting only takes into account the very near-term, and it only involves choosing a direction and an amount. Moreover, spread betting involves leverage, meaning a trader doesn't have to commit the full capital needed for the transaction. The broker loans the bulk of the amount.

Instead, the trader puts up what's called a stake. That stake is like the bet in blackjack or in the strike/ball bet in baseball. However, the outcome in spread betting isn't just a simple win/lose proposition. The gains or losses in spread betting are decided by the number of points the market moves while the bet is in place.

In forex trading, the smallest movement in the price of a currency pair is called a pip. The number of pips moved in either direction determines the loss or gain on the bet. Multiply the number of pips by the stake and you get the gain or loss for that spread bet.

So...you're spread betting in the euro/yen currency pair. You bet the pair will go up in price. Your stake for the bet is $1,000. The price goes up three pips before you close the position. You made $3,000.

You make another spread bet. Again, you're betting the price will go up. However, this time, it falls five pips before you give up and close the position. You lost $5,000.

Lather. Spread bet. Repeat. And pray.