Advantages and Disadvantages of Financial Spread Betting

Disadvantages of Financial Spread Betting

Disadvantages of Spread Betting
In the UK we can bet on the markets in a tax-free trading environment – if you are not a UK resident then you may not be able to spread bet although some providers do allow international clients. Having said that you can always look into CFDs; which work very much like spreadbets. This page is designed to warn you of the perils of spread betting, it is not designed to promote spread betting or provide you with the basics. I'm willing to bet has caught out 95% of all people who've spread bet at some stage. These are valid flaws in the spread bet world, some players are trying to implement measures to reduce them – fair play to them, but the big players aren't.

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. You must remember that you are not trading the market, the spread bet provider will try to 'match' the market as close as possible, but if you compare actual market charts with those from your spread bettor they are likely to differ for that very reason, it's a 3rd party/synthetic created price trying to match the underlying market. So you HAVE to trade from the price structure of the spread bettors charts – not your main, market accurate charts! This is especially true when trading away from the daily rolling bet options and into future dates.

Now some of you will say the following and so will the spread betting providers – 'Widen your stop placement/take account of the spread in entry and stop placement' and you have to, I do – BUT, you have control over that, what you don’t have control over is the sudden widening of spreads which are totally beyond your control. If this happens to you, the easiest thing to do is check with your spread betting company if the trade actually traded at the price that knocked you out, this will have the following effect:
  • It might help rescue a losing day/week/month into a breakeven or winning one
  • It might help your P and L over time
  • If enough people do it, it will waste the time of spread betting companies, the clever ones will act to resolve the problem by implementing measures to avoid the said false trades – i.e. fixed spreads! And in fact this is what's happening - more and more providers now offer fixed spreads.
and can I just say that I was reimbursed for a Gold trade which would of gone unnoticed had I not queried it! (which is why keeping records and reviewing them makes sense)

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) - the exception to this is Ayondo that only charges financing on the amount you actually borrow from them - 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).

⇑ ⇑ ⇑ ⇑ Listen to our podcast summarising the potential Dangers and Disadvantages of using Spread Betting to Trade.

On 24 hour markets such as FTSE100, S&P500, Forex etc – the spread is likely to INCREASE in after hours trading, for instance on the FTSE100 the spread during market hours (08:00-16.30) is 1 point, after these times the spread can widen to 5 points.

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. Again the exception of this is Ayondo which has a policy of waving negative balances meaning that clients can never ever lose more than they deposit.

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 FCA 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 FCA 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.

The spread you're quoted does not always remain static! - It can widen by 2,3 or 4 times on the open! If your strategy calls for a tight specific stop (as most of mine do) then this sudden widening of the spread can wreck a perfectly good trade and force you to have a loss, if you've 5 trades live that all do this, you've just taken a fairly sharp hit through no fault of your own – The answer of course would be for the spread bet providers to provide fixed static spreads, I for one would be perfectly happy to pay a little bit extra on the spread (not points! but a small % of a point) or a fixed cost for opting for a fixed spread. Thank god a few providers are seeing the light and providing fixed spreads (InterTrader).

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. But one warning for shorters! Spread betting is a leveraged game, for a few £'s you gain control over £1,000's of a market – this page is not designed to explore or comment on leverage – that can be sorted directly by the trader, it's the traders responsibility to place suitable stops, not the spread betting providers – the only point around this area I'd like to mention is DIVIDENDS – the spread bet price will FALL when a dividend is due to be paid and if you are short a market and hold when a dividend is due you might have to stump up full cost of the dividend! So going back to leverage, let's say you're short a stock priced at 500p @ £10 point you are controlling £5,000 worth of stock, if the divi is 6% on that stock and you're short, you might have to stump up £300 which obviously is a direct cost to your business! You can do the maths based on the market price times the £ per point/pip etc and check to see when/if a dividend is due on the stock you plan to short.

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.

The bottom line in trading is you make your profit by having more £ winners than losers, your success rate might be 70%, it might be 30% but the bottom line is if your £ winners are greater than £ losers + costs you'll win over time. Now by widening stop positions for trades reduces the overall mechanics of potential profit and loss! so it's easy to say just double/widen the size of your stop – by doing that you might turn a 3R which would make money, into a 1.5R set-up that loses money! Yeah I widened my stop to account for random spread fluctuations, but I don't seem to be making money! I wonder why! – you've done the logical thing, you've kept the BMW's and Merc's in place for the managers of the spread betting companies yet you've lost out financially! Somethings wrong with that.

Having said all that, you have to work within the framework of your spread betting provider, no matter how good or bad they are, so when designing set-ups and systems it's best to over compensate for stop/entry placements to avoid the above and just accept that you might be halving a perfectly brilliant set-ups R value profit potential (say 6R down to 3R) – the playing field is not fair and is why I suggest all spread betting companies employ fixed spreads or at least provide traders with the option of choosing a fixed spread – those that want to use them will and those that don't won't!

Over the years the only problems I've personally had have been using too tight a stop (my fault), being flicked out at the open from suddenly widening spreads of up to 4 times the norm and the odd trade that has not been paid correctly (such as being stopped out when price never traded there). Most of the other problems are trader specific and responsibility lies with the trader there.

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.