Many investors wonder how financial spread betting companies in the U.K. make money when they don't charge brokerage fees on bets placed. Below we look at how spread betting companies generate revenue, whether they make money from spreads (or whether they profit by trading against their clients), and what investors should look for when choosing a broker.

Basics of Spread Betting

Spread betting is a lot like gambling in that an investor speculates which way security prices will move. Rather than buying or selling (or owning) the asset, the investor will try to guess whether its price will move up or down during a certain period of time, based on the buy and sell prices offered by a broker. As an investor, you make your bet on whether you think the price will rise or fall. The more it moves, the more profitable it is for the investor and, therefore, for the spread betting company.

One thing to keep in mind: financial spread betting is illegal in the United States. It is, however, legal in the United Kingdom. In the U.S., it should be noted that the derivatives markets effectively allow people to take the same risks, through various option strategies on optionable underlying securities. While perhaps a little more complex, the net intent is the same: a directional bet. Since spreads are historically narrow, these types of bets might have broader appeal to experienced investors.

Revenue From the Spread

First and foremost, spread-betting companies make revenue through the spreads they charge clients to trade. In addition to the usual market spread, the broker typically adds a small margin, meaning a stock normally quoted at $100 to buy and $101 to sell, may be quoted at $99 to sell and $102 to buy in a spread bet.

The buy price is always higher than the sell price, ensuring the broker makes a profit from the spread, whether the client wins or loses.

The A Book and the B Book

Brokers categorize clients into two separate categories, or their A book and their B book. Traders who have a track record of losing money are placed into the broker's B book. Bets from B-book clients are not sent to the market. Instead, the company actively bets against them. In this scenario, the broker stands to win when the client loses, and vice versa. Since studies show that 82% of traders lose their deposits, this model has proven to be extremely profitable.

There is, however, some risk involved with backing B-book clients. Spread-betting companies have risk limits, and if too many clients bet in one direction, these limits are breached. Brokers must then hedge their bets to restore risk to an acceptable level. Brokers avoid hedging B-book clients unless absolutely necessary, because they are effectively paying for another spread, therefore increasing bottom line costs.

A-book clients are a similarly dependable stream of revenue and provide opportunities to capture commissions. They trade enough that risk is substantially lower than B-book clients, and they often enjoy a relationship in which they are trusted to expose the market (and not the broker) to risk. Such clients are often charged a premium on the standard spread, or a specially negotiated fee.

However, IG Group, a spread betting company based in the United Kingdom, says it doesn't profit off the backs of its clients—especially those who are unsuccessful in their trades. According to its website, the firm says its clients mainly offset each others' positions, so when one client buys one lot of an asset, another one sells another lot, which covers both sides. Since there is no exposure to either client's profit or loss, IG says it makes its money off that spread.

Associated Trading Costs

Spread-betting companies allow their clients to continue trading throughout the global trading day, Monday to Friday, from the time the Asian session opens to the time the New York session closes. The flipside is that spread-betting companies typically charge a holding fee to carry a position overnight. Beginners often get distracted by an attractive spread and miss these ongoing trading costs, which in time are likely to erode profits. It is therefore in the best interests of the broker to keep clients holding positions as long as possible, as they stand to generate more revenue from associated fees.

Regulatory Environment

Spread-betting companies are subject to strict regulations worldwide. The European Securities and Markets Authority (ESMA), for example, passed and enforced regulations that limit certain types of financial betting. In 2018, ESMA upheld a ban on the sale of binary options to retail customers, which may change some investors' interest in spread-betting companies.

Finding the Right Broker

Spread-betting companies obviously make a lot of money, but how can a beginner get involved? The first step is choosing the right broker, sometimes a misstep for overeager traders who often squander their initial deposits. The markets may move against a trader, but more often than not, it is the choice of broker that determines overall success. Does the client bet on commodities or interest rates? How important is customer support? Which broker has the lowest spreads? These are important concerns when considering which spread-betting company to choose. The other thing to consider, especially if you're new to the game, is a broker that offers a demo account. This allows you to practice how to spread bet without the stress of losing money.

Spread Betting Companies

There are a number of different companies that allow investors to open up accounts and begin spread betting. Here are a few:

IG Group

Founded in 1974 solely as a spread betting business, IG Group is based in the United Kingdom. The firm now provides investors with other services including online forex and share trading. IG Group also offers demo accounts to new clients. It claims to have more than 178,000 clients worldwide.

Intertrader

Intertrader was founded in 2009 and is part of Entain, a publicly traded sports betting and gaming company. Intertrader says it is a "100% market-neutral broker," meaning it never trades against its clients. Along with spread betting, the company offers forex and contract for difference (CFD) trading. Intertrader promises new investors a risk-free spread betting environment with its demo account.

ETX Capital

ETX Capital was founded in London in 1965. The firm's areas of specialty include spread betting, forex, options, commodity, equity, and bond trading. New investors can sign up for a demo account to practice their trading strategies before jumping in.

The Bottom Line

Taking advantage of online spread-betting comparison resources, using price comparison tools and keeping a level head means that a trader can feasibly share in the wealth that spread-betting companies have created. But knowing how companies work and choosing the right one for you is crucial if you're going to succeed. Make sure you do your research before you commit to a platform.