The idea of using spread betting as a speculative tool to gain exposure to the stock market in the UK has been growing in popularity. In the early years, financial spread betting was limited to institutional investors, city traders and high-rollers however the product has now spread amongst smaller investors and spread betting in the UK keeps growing in popularity. The opportunities for private traders to have access to the same markets and to use similar trading mechanisms as the professional traders has meant that they have become more sophisticated in their requirements and more successful in their application of trading strategies.
Private individuals spread betting in the UK on currency markets are playing a fast-growing role in the burgeoning global business of foreign exchange, which has skyrocketed to a spectacular £1.1 trillion worth of trades each day.
Moreover, according to the triennial survey of foreign exchange and derivatives markets by the Bank for International Settlements - which involved 52 central banks - more than half of all global daily trading occurred in the UK.
The bulk of the global jump - a 27% surge from £834bn in 2001 - can be put down to the greater number of foreign currency trades necessary in an increasingly globalised and interconnected world, along with a spike in the number of forex-betting hedge funds.
However, the role of spread betting punters from the United Kingdom has also continued to grow exponentially. James Parker, a forex trader with financial spread betting UK specialist City Index, said that while private-individual foreign currency bets ranged from around £3 to £1000 per point, the quantity of bets had increased by more than 800% in the last 12 months alone.
The increase in interest in foreign exchange betting is massive. It began with the downturn of the Nasdaq bubble, when non-institutional shareholders started to drift out of the traditional equity markets. But there is also the point that people are able to bet on currencies easier now than ever before, particularly with spread betting uk Internet dealing and phone services available.
Parker added that UK spread betting "tends to increase when the currency markets are at their most volatile", and that the most common spread betting currency bets in the uk over the past year have been sterling/US dollar, followed closely by euro/dollar, dollar/ yen and dollar/Swiss franc.
Perhaps most startling, however, is the exponential growth in the number of traders in foreign currency options and derivatives, which some industry experts said increased by a factor of 25 over the past year. Parker said many private individuals now "seem to be acting on snippets of information about relations between countries".
According to the BIS study, foreign exchange market turnover in the UK increased by 49% between 2001 and 2004 to £418bn per day - with London maintaining its position as the world forex capital. The US increased its turnover 82% to $461bn (£257bn) .
The largest percentage growth - 94% - in the three-year period was in "outright forward transactions", the sale or purchase of foreign currency more than two business days after dealing. The next largest growth area was spot trading, which is the exchange of two currencies at a rate agreed on the date of the contract, which climbed 47%.
The study also noted outright forward trades accounted for 14% of total UK foreign exchange activity, compared with 11% in 2001. Electronic trading accounted for 55% of all foreign exchange activity.
The bearish markets over the past two years have seen private clients lose substantial amounts of money with the stockbroking firms - and they have paid commissions into the bargain. Also, some serious questions have been raised about the quality of the research that has been produced. It's one thing to pay commissions when the research results in a profit. It's a completely different story to pay commission and lose on the trades. The upshot is that more punters have turned to the spread-betting format, one that is perfectly suited to the volatility that has become a daily feature on traders' screens.
Yankee, Lucky 63, Heinz and Goliath may or may not be familiar betting styles but the word on the street is that uk spread betting is on the rise. Indeed, as Lee Oliver reports, it is opening up the market for a wider variety of participants to trade binary options.
In the not too distant past, most people would have placed uk spread betting firmly on the fringes of what was considered the proper financial market place. People who used spread betting companies in Britain were seldom called investors or traders, but rather punters or worse, 'spivs'. Spread betting in the UK was undoubtedly regarded by many as the near perfect product for engaging in a little bit of no good, or dodgy dealing, based on factors such as a discrete 'nod and a wink' in a City bar.
Some of this reputation persists today, as evidenced in the saga surrounding the alleged antics of 'The Plumber', the nickname of UK entrepreneur Paul Davidson. He is currently appealing against a hefty £750,000 fine handed down by the UK's Financial Services Authority (FSA) for a spread bet apparently designed to boost the share price in the grey market of a company he was about to float on the stock exchange.
However, despite incidents of this nature attracting negative publicity for the spread betters, the fact that FSA has taken action does highlight the fact that it is a regulated industry. In other words, dodgy dealing through a spread better is as illegal as through a traditional stockbroker.
UK Spread betting has become a very popular activity with the number of people places at least one trade a year having peaked at more than 100,000 in 2012. [Investment Trends Report 2012]. Numerous new companies have been attracted to the business over the last few years, including many associated with traditional money brokers, such as Cantor Fitzgerald's Cantor Index and ex-Tradition's ETX Capital.
Many would claim that far from being 'spivvy' bit players, the spread betting firms in the UK have actually done the wider market place a huge service by taking what are still often seen as complicated instruments and repackaging them for a wider audience.
Virtually every product that exists in the mainstream market, plus several more that do not, are easily available in some shape or form through the spread betters. And, increasingly, an evolving diverse clientele is using these. 'Ten years ago, spread betting in the UK was limited to City professionals but now it is widespread among those who simply have an interest in the financial markets, rather than being actively employed in them,' says John Austin, director of new products and services at IG Index. A large majority of IG's clients fit this 'interested amateur' profile.
Amateur does not mean 'mug' - our biggest winning client is a GP; our biggest losing client is a well-known name in the City
John Austin, director of new products and services at IG Index
Jayne Banks, communications officer at CMC Markets, agrees that the spread betters' client base has widened: 'Well over 95% of our clients would be recognised as retail investors rather than professionals. They are often people who have had some experience in physical share trading but are looking for a more cost effective and flexible alternative. UK spread betting firms tend to have a short to medium term view on an instrument and are therefore quite active - some clients have been known to trade 500 times per day.'
This diversification of client base is something that the exchanges themselves have by and large failed to achieve. Despite numerous initiatives, the retail sector, especially in derivatives, does not appear to have come swarming into the mainstream market. Yet the uk spread betters all say that a vast amount of their business is now coming from 'the man in the street', rather than 'the man in the City'. Not only that but as the number of people made redundant has been increasing and bonuses have fallen, the number of city traders, former estate agents and car salesmen opening personal spread betting accounts to supplement their income has increased.
Broadband has also been behind bookmakers' move into financial spread betting. The internet has undoubtedly helped by providing a cheap distribution network. It has also helped add transparency and intense competition. In the summer of 2007, Paddy Power was the first of the mainstream bookies to bring a financial spread betting product to the market, and was followed by Betfair, PartyGaming and Victor Chandler. The old claims that the spread betters tended to shade their prices too much when called by clients have virtually disappeared. There is simply too much choice for the clients, who are notoriously fickle and will apparently switch their business elsewhere with little consideration.
It is almost a symbol of this country that the bookies are finally catching up on the stock market. Paddy Power and other bookies commonly come up with eyecatching publicity stunts. This may be for publicity reasons...but if it is for real, then the regulator should have a look at it.
Another important factor behind why retail users have flocked to the uk spread betting companies at the expense of more traditional brokers is probably a result of the way the UK spread betting companies have repackaged the products they are offering.
A spread bet on the FTSE-100 is effectively nothing more than an OTC version of the futures contract that trades on Euronext Liffe, although many of its users may not know that. By making such products available in virtually any amount, the uk spread betting firms have arguably opened the market up to a far wider range of potential clients.
A good example of the repackaging of a complex product is the concept of binary bets. The spread betting firms in the UK have translated the probability factor in the option's price first into odds and then turned them effectively into a spread bet. These are, by all accounts, proving incredibly popular. Because of the way they settle, normally either at zero or 100, they are technically classed as a fixed-odds bet and so do not have to come under the jurisdiction of FSA.
At first glance, this seems a little strange. It is inconceivable that a retail client could ring up an investment bank and ask for a binary option on a market and take a position. But that is exactly what he can do through the spread betting firms in the UK. (or more accurately their subsidiaries).
They are classified as fixed odds because that's mathematically what they are
IG Index's Austin
IG index's Austin does not see this as a problem. "They are classified as fixed odds because that's mathematically what they are. We would much rather classify them as spread bets, as the betting duty would be lower," he says. "The audience for them is a mixture of spread betting clients, who find the binary pricing scale intuitive and very easy to understand, and fixed-odds clients. There is no simpler concept in speculation than a straightforward 'yes/no' proposition, and this is what a binary bet represents and also why they are so popular," he adds. In other words, unlike with normal spread bets, clients using binaries know exactly how much they stand to lose (or make) as soon as they take their position.
With their wide range of products and increasingly diverse clientele, it seems the uk spread betting companies have moved mainstream. This raises the issue of how much competition they pose to not only traditional brokers but also, perhaps, to the main markets themselves.
Austin, however, is more direct. "During the market slump between 2000 and 2003, uk spread betting companies continued to grow while stock brokers had a horrible time. In terms of competing for the business of the active trader, there is no comparison: the gearing, the ability to go short and the freedom from stamp duty and capital gains tax make spread betting in the uk a much more attractive way of playing the market for everyone except the riskaverse and the long term investor. And there's also the convenience of being able to trade everything, shares, fx, futures, options, binaries, even sports events, from a single, cross-margined account."
CMC Markets's Banks agrees: "For active traders spread betting in the uk is already viewed as mainstream. The active traders are the high value clients that are moving from brokers and physical shares across to the executiononly derivatives providers. Traditional brokers are recognising that to keep their most valuable clients happy, they need to offer more cost effective and flexible products. That is probably why we've seen a steady stream of companies introducing spread betting and contracts for difference (CFDs) to their range [of products] over the past year.
"Spread betting in the United Kingdom is attracting the most active clients away from the traditional brokers, so it is attacking their revenue stream. It is possible for the two products to work in tandem as clients use different products for different strategies. It is likely that more brokers and banks will recognize that they need to introduce spread betting and CFDs in the uk to keep the active clients' trades in their domain and not lose them to the competition."
Traditional brokers will never be made redundant because people as a whole are still adverse to change. Financial spread betting still holds negative connotations but the uk spread betting industry has definitely moved mainstream. Hundreds of our clients share trade solely through us as they used to with traditional stockbrokers and so we are becoming more competitors rather than complementary
head of sales and marketing at FinSpreads
Nonetheless, the UK spread betting firms do not see themselves as a threat to exchanges, even if they strive to maintain as much of their business in-house to keep the spread for themselves as profit.
"The majority of business that we take is hedged in the market and so it does flow onto London Stock Exchange [and other exchanges]," says Campbell. "Our business does not challenge the position of the exchanges."
Banks adds: "CMC Markets does not directly back every position off in the marketplace. However, we manage our risk through portfolio hedging, which means placing large volume trades into the market on a daily basis. I would estimate that a large number of trades being transacted across the physical exchanges can be attributed to the spread betting and CFD industry, so we are helping to bolster the exchanges rather than threaten them."
Austin states categorically that the spread betting firms will not challenge the position of the exchanges. "The liquidity on established financial exchanges, like LSE, is a reflection of a vast global game. Whether and how much the uk spread betting companies choose to hedge is never going to make much of an impact,"he says."In terms of starting up direct rivals to the exchanges I would say that, although there have been a couple of attempts to start new betting exchanges recently, for both binary bets and conventional spread bets, the size of the UK retail speculation market is probably not sufficient to generate sustainable liquidity in any but a couple of the simplest and least volatile instruments. None of the recent start-ups show any sign of real success."
Although, this is not strictly true, as Austin explains: "There's only one example of a retail speculative platform achieving genuine liquidity, and that's the sports betting department of Betfair. It was able to achieve liquidity because it was up against the lumbering dinosaurs of the established fixed-odds gambling industry."
Looking ahead, it seems likely that uk spread betting will continue to grow in popularity because the companies that offer them have effectively made many markets extremely accessible. But, like any trading instrument, they may not be suitable for all types of investors, even if they are proving increasingly popular with participants across the whole of the market.
"Spread betting is at the high-risk end of the spectrum - it is highly geared, and is economically similar to trading futures. At IG we make it clear in our risk warnings that clients should only speculate with money they could afford to lose if the worst came to the worst," says Austin. Banks concurs:"Spread betting is high risk and it is very important to understand the nature of the product, how it works and what the risks involved are. The uk spread betting companies offer seminars and education in spread betting. We want our clients to be successful as we want them to keep on trading with us."
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