Advantages and Disadvantages of Financial Spread Betting

Disadvantages of Financial Spread Betting

Disadvantages of Spread Betting
Danger of being careless and betting too large a size for your finances - The gearing or leverage means that although you can make money ten times faster and ten times greater but you can also lose money ten times faster and ten times easier and ten times greater if you're not sufficiently trained.

A disadvantage of spread bets is that the bookmaker's spread tends to be slightly wider than commission one might pay to a stockbroker - This partly reflects the gross profits tax which bookmakers pay of 3% of gross profits.

An important disadvantage is that the funding cost (typically at around LIBOR +1-2%) is charged on the entire position (usually this applies even where the client has been required to deposit some funds as margin with the bookmaker) - I suspect that a large part of the bookmakers' income is attributable to the funding charges. For long positions held for more than a few weeks, the cost of funding tends to outweigh saving on stamp duty (although if the investor wants leverage, a spread bet is still probably cheaper than most alternatives).

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You can lose more than your initial deposit or capital. - The margin trading involved means that while potential profits are magnified, potential losses are also magnified, except for trades with stop losses. With ordinary share trading, you cannot lose more than the amount you invested in the shares. There is no such limit with spreadbetting.

Another problem with spreadbetting is the sheer volume of capital you have to tie up to keep your trade in play. - It always comes down to how much you are willing to risk on the trade. If you enter a long position on the FTSE at 5950, then betting £10 per point and setting your stop at 5850, it would be very easy on a normal trading day for the FTSE to fall to 5850 - so you close your trade at a loss of £1000 - and still close the day above the 6000 mark. Of course, you could set your stop lower but the lower you set your stop the more of your capital you put on the line and the greater the potential for one wrong trade to wipe out the bulk of your account.

The FSA considers spread betting as a gambling activity - This in itself has its pros and cons...if you tell your wife that you're trading she's more likely to be understandable . However, also keep in mind that winnings are free of tax for a reason - the FSA believes that more people will LOSE than you'd better be smart aisle.

Many spread-betting markets are very volatile - In reality periods of high volatility can either be a good or a bad thing. Sharp movements in prices can quickly turn unrealised profits into losses and unless you make use of stop losses (or better place a 'guaranteed stop-loss') you can suffer large losses if the markets go against your position.

Spread bet winnings are not taxable, and correspondingly there is no relief for losses. - This is not a problem for speculators looking to day trade the markets but may represent a problem for an investor who uses spread betting as a hedge for his stock portfolio especially if the share was bought at a low price that is sold later in the same tax year.

The investor does not own the instrument he trades - This means that he does not receive any of the benefits he might expect with share ownership, such as dividends and voting rights. As the investor doesn't actually own the shares then he will not be able to vote at AGMs or EGMs. Of course, a stock's dividend is already factored into the trade's bid-offer spread, from which you benefit...

Spread bets have a specified lifetime and cannot be carried over after their expiry date - So the investor cannot hang on hoping for a long run improvement. The only way to continue trading the same instrument is to close the current bet and open a new one. With conventional share dealing, you crystallise your loss only when you sell the shares (no expiry date). Although I have to say that the rolling dailies have gone a long way to resolving this issue.

Trading costs in spread betting increase over time - For short term positions held for a few weeks or months, spread betting costs are very competitive compared to ordinary share trading but if you want to hold the position for more than six months, or become a long term investor, it is cheaper to buy the shares in the conventional way. This is because costs are incurred each time a spread bet is 'rolled' over or extended to a new expiry date (all spread bets have a definite expiry date) If you wish to run your bet beyond the expiry date you must roll your position over from one quarter to the next.

The spread is different to the cash market spread - you have to factor a certain increase or decrease in the price before you are in profit (due to the evil bid-offer spread...).

It is difficult to make money in the long term from short selling - The general drift of share prices is upwards; and a short position which goes against the investor can quickly become a very large problem. Also, with the ability to go short comes the possibility for an unlimited loss, as theoretically the potential rise in the price of a share is unlimited. Having said that, if you understand the perils of excessive leverage and can avoid the temptations in practice, a spread bet may be the most cost-effective way of taking a short-term position.

The real enemy of spread betters are range-bound markets - For instance if you have the FTSE 100 index closing at 5,262 every day for weeks, it can be a remarkable disincentive to trade. On the other hand spread betters thrive in periods of volatility. When the Dow Jones moves 750 points in a day, first by opening 200 points down and then moving more than 500 up, that's a real opportunity to make money for a sophisticated investor.

Remember : With spread betting there are real charges: They exist in the spread
Spread betting agencies tend to promote their service on the basis that one of the advantages of using this method of investing is in the fact that they do not have transaction charges or fees. This is simply not true - the transaction charge is firmly embedded in the spread. These apparently superflous costs can have a dramatic effect on profitability over-time particularly if the trader tends to do a lot of short-term trades. If you are serious about spread betting then you have some homework to do, and the very first place you must start is in an analysis of spreads offered by different spread betting agencies. Currently Ayondo seem to have some of the tightest spreads around.