Derivatives and the History of Spread Betting

Q: How does it differ to conventional betting?


A: In normal fixed odds betting, you take a view on a horse race or a football game and look for a win or lose situation. However, in financial spread betting, there is no finishing line. You are not looking for a final result at the end of the race. Instead, you are making a prediction about where prices will be in a single moment in time; spread betting is a way of backing your view on where the financial markets are going. With spread betting, the more right you are, the more you can win but the more wrong you are, the more you can lose - and your loss could be substantial if you don't use stop loss orders (covered later).

Q: What is a derivative product?

A: Derivative products such as spread betting have helped to revolutionise the industry for private investors. A derivative product derives its value from its underlying asset. The underlying asset can be a share, an index, a currency pair, commodity or indeed any other asset. Spread betting like CFDs are a form of a derivative product meaning that you do not own any of the shares you are trading but are simply trading on the direction of the share price. For every point the market moves in your direction you win multiples of your stake (the opposite is also true: for every point the market moves against you lose multiples of your stake!). Since you don't own the underlying asset but are betting on price movements you can profit from falling prices by taking a DOWN bet. Even if you intend to continue buying and selling shares the conventional way, the innovations that we have witnessed with derivative providers' products and increasingly sophisticated online trading platforms have contributed to most brokers now offering facilities such as stop loss and limit orders, free realtime prices, supplementary charting tools and research - all of which were either unavailable or were prohibitively expensive for a private investor just a few years ago.

Q: Tell me a little about the history of spread betting?

A: Some financial historians trace the origins of spread betting back to the United States and the unregulated 'bucket shops' in the early part of the twentieth century. However, it is now widely accepted that it wasn't until 1974, when entrepreneur Stuart Wheeler came up with the idea to give investors the opportunity to speculate on movements in the price of gold - whether up or down - that spread betting as we know it today was born.

Spread Betting is a tax-free alternative to trading shares and financial markets. You are essentially betting on the performance of a share, index or commodity. You don't own the share itself, you merely use it as an underlying instrument for your betting.

Stuart Wheeler, an unemployed stockbroker at the time at first introduced the concept of financial spread betting to some of his friends, deciding a sell and buy price and then letting them to bet on whether the index would rise or fall over the following week. Even though the losses accumulated could be greater than an investor's initial outlay, it became immediately evident that a key advantage was that this way of trading would allow traders to gain from a declining market as well as a rising one.

The word soon spread out across the City and in 1975 Wheeler transformed his idea into a business. By his idea Wheeler had created a more accessible, not to mention tax-free, alternative to traditional investing and had opened the door for a new generation of financial trading products to join the market place, initially spread betting exclusively on gold and later on foreign exchange, commodities and index markets as the demand continued to expand.

Q: How long has it been around?

A: Financial Spread Betting has been around just over 40 years and it has steadily increased in popularity over the last 10 years. To focus specifically on financial spread betting, trading shares via this method is a relatively new phenomenon and has only been around since the late 1990s. It is also worth noting that at first spread betting was limited to the various futures markets out there. In fact, until quite recently, spread betting was mainly regarded as the preserve of the city elite, with their exceptional grasp of the 'dark arts' of stock market prediction and the incomprehensible jargon of trading terms - not to mention the financial resources to absorb potentially sizable losses. The fact that spread betting providers tend to advertise themselves as tax-efficient investment products tells you that this isn't aimed at the casual punter. The spreadbets are mainly used by speculators who typically hold them for a short period of time, compared to shareholders who tend to hold their assets for longer.

Recent industry derivatives research and studies show that the average investor is now much more sophisticated and knowledgeable about financial matters than they were 10 years back. During this time there has been a growing awareness of the advantages that spread betting has to offer over traditional trading on the financial markets. A decade ago you would have needed a minimum of £5000 to open an account, however today spread betting is a much more mainstream product and there are fewer restrictions; presently anyone can open an account (you can open one with just £100 if you wanted to!).

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