Why Spread Bet at all?

Ever thought you would like to trade stocks and shares more frequently, but were somewhat worried that the commissions you pay your stockbroker every time you trade eat into the value of your shares portfolio? Financial spread betting could be the answer.

You might have already experienced buying and selling shares through a traditional stockbroker. But what if you could access more markets and have more investment choice? What if you had the potential of being able to profit in any market condition while initially paying only part of the full market value of the deal? What if there was no separate commission and everything was built into a narrow spread?

Let's face it; the idea of making money out of backing your own judgement is very tempting, particularly when you believe that there is an anomalous situation in stock market valuations which you think will be corrected or when you spot a trending market and want to take advantage of it by riding the rise or fall so long as it lasts. Financial spread betting permit you to do this efficiently without needing access to vast amounts of capital.

Today I want to address a question I'm often asked by spread betting newbies or those thinking about getting into the game but need a little extra convincing - namely, what are the advantages of spread betting over other forms of trading?

Arguably, perhaps the biggest benefit is that spread betting on commodities, indices and other financial instruments is that it isn't technically trading at all as you don't ever actually own any assets, you just bet on their movements.

This means, in the UK at least, spread betting is classed as a form of gambling rather than financial trading and as a result saves you a whole heap of costs and taxes that other traders incur - spread betting profits are free of capital gains tax, there is no stamp duty on trades and you don't have to pay any fees or commission to brokers.

But there are also many more benefits to spread betting than just tax issues and several of these help to make spread betting particularly accessible for those with limited experience in the markets or with limited funds to play with.

For instance, with spread betting you can start by only risking small amounts, say £1 for each point movement, and you can also use stop loss orders to provide a safety net and terminate a bet once your losses hit a certain point. This doesn't limit your losses to £1 however. Even a small movement in the price could result in relatively large profits or losses being realised.

It also allows you to take advantage of bear markets (those which are in decline over an extended period) by 'going short' i.e. betting on the value of an instrument to fall, something that, before spread betting came along, was really only open to the wealthy and professional traders. This is because, with spread betting you can make money from a falling stock or commodity price in much the sam way that you can from a rising one. There's a number of advantages to spread bet vis a vs regular betting and FX trading, see AVATrade's financial spread betting program for more on this.

Why Spread Trade?

As we have already said, spread trading has really taken off in the UK in recent years and is certainly my preferred method of trading the markets.

Although it has been available for a while to those in the know, it is the Internet and the ability to trade with live prices on-line that has been the catalyst for it's recent explosion in popularity. The Internet also enables non-UK residents to trade with UK spread trading companies, but check your local laws and tax regulations. For example, spread trading is currently not available to USA residents. UK spread trading companies are not allowed to let USA residents open accounts. Whereas at the time of writing it is becoming very popular in Europe as well as Australia with UK companies opening branches in Australia.

For ease of explanation, I will assume that you are a UK resident. The reason why spread trading is not available in all countries is the very reason why it is so popular in the UK - because it is classed as gambling. But in the UK that gives us a huge tax advantage.

In terms of trading costs, other forms of trading such as buying and selling shares, can mean you incur costs which include things like -:
  1. The market spread (difference between the buying and selling price)
  2. Stamp duty
  3. Broker fees
  4. Income tax on dividends
  5. Capital gains tax on growth profit (share price increase)
  6. ...and a load of paperwork to do for your tax return.

Six Advantages of Spread Betting

There are a number of advantages to spread betting:

  1. Spread betting profits are tax free and free of broker commissions
    The major advantage of spread betting is that all profits are free of capital gains tax (CGT), and potentially UK Income tax too. It is difficult enough right now to make money on the markets, without the Inland Revenue taking away a large proportion of the gains. Also, as opposed to normal share trading, there is no 'commission' or 'UK Stamp Duty' (0.5% of the trade value) to pay.

    Avoid stamp duty.
    • Share trading incurs a 0.5% stamp duty which reduces the effectiveness of day-trading traditional stocks and shares. When buying a spread bet on the same share, you do not which adds to the appeal of spread betting.

    Avoid commissions.
    • With spread betting there is no commission attached to your trades. Commissions start at around £15 and are payable on both sides of trades. On Capital Spreads, for instance, the entire spread around the underlying market price in FTSE 100 stocks is just 0.1pc (i.e. 0.05% above and below the bid/offer on the London Stock Exchange). On a trade at £50 per point (equivalent to 5000 shares) for a commonly traded stock like Barclays at £3.50 would cost a buyer (if he paid only £15 opening/closing commission) £102.50 in various fees/taxes. With Capital Spreads he would pay just £8.75. To put this into perspective Barclays is traded on about a 0.5p bid/offer spread on the Exchange. Your various costs would add over 2p to the price. This far outweighs any resulting benefits of being able to place your order within the spread on a Direct Market Access platform.

    Avoid capital gains tax.
    • A 0.5% saving on stamp duty is useful but it is not the kind of money that most retail investors will get out of bed for. The real advantage is that profits are free of capital gains tax in the UK, Ireland and to my knowledge Australia. As the Inland Revenue treats spread betting as a gambling activity, you are not liable to pay capital gains tax on your profits (technically, your 'winnings'). This by itself can save you 18% of potential profits in the UK and probably much more than this in Ireland/Australia.

    Avoid tax on dividends.
    • Owning a share of stock is the same as owning a piece of a company and this entitles to a dividend; but this is also treated as income and tax is payable on dividends. Spread bets do not pay dividends but the dividend is still factored in the price so if you're a holder of a share that pays a dividend you still stand to benefit from this in the form of a tax-free capital gain, as opposed to taxable income.

  2. You can minimise risk by restricting your losses
    With spread betting, you can guarantee your 'stop loss', or the point at which you exit your trade. A conventional share purchase also allows you to set a stop loss, but this is not guaranteed. Therefore, when your share moves a great deal overnight, your broker may not be able to get you out the next morning at the stop-loss price you requested. But spread betting is different. Even if the shares move a great deal, you'll still be taken out of the bet at the guaranteed stop-loss price you asked for - the spread betting company has to swallow the extra cost itself.

  3. Use bear markets to your advantage by going short
    'Going short' means reversing the normal process of buying low and selling high. When you go short you first sell high and then buy low at a later date. You do this by borrowing shares from a broker in order to sell them. When you buy the shares, you're actually merely giving back the shares you borrowed. The further a market falls, the lower your buying price and the more profit you'll make.

    Going short of a market or share is something that only insiders or the rich were able to do until recently. In a bear market, going short is one of the few ways of making money and spread betting is the easiest and most efficient way of doing this.
    Here's an example on how to profit from going short:

    You believe that AstraZeneca is overvalued.
    • The spread betting company quotes you 1864 - 1872.
    • You 'sell' £30 a point at 1864.

    The market then slumps, dragging AstraZeneca with it.
    • The company is now quoting AstraZeneca at 1844 - 1852.
    • You decide to close your position at 1852.

    Your profit is (1864-1852) x £30 = £360, free of capital gains tax.

    One of the most famous bear spreadbetters in the markets in the last decade has undoubtedly been Simon Cawkwell, aka Evil Knievil

  4. You can start small with spread betting - before hitting the big-time
    With spread betting you can choose exactly what the size of the bet is going to be. The range can be as low as 1p 'a point' with financial spreads to hundreds of pounds per point. This means that not only can you trade as small or as large as you like, you can also enter and exit positions in stages.

  5. You can lock in some profits, but keep the bet open
    Unlike betting on a horse, with spread betting you are not locked in until the result is known. You can close a bet at any time, even just a few seconds later. And you can also close off part of the bet to lock in some profit, but keep the remainder of the bet open in order to try to make more money.

  6. Use it to hedge your portfolio
    Hedging has only been available to large institutions, banks and wealthy individuals until very recently. As an example, if you think the property rise has been unsustainable, you can hedge against the value of house prices going down by spread betting on the property market.

    Small investors can now compete on the same level as the large financial players, giving the equity market a new dimension. This aspect of spread betting is still a point that is under-emphasised in the mainstream financial media. In some ways this is hardly surprising, because if you gain knowledge of even the most basic aspects of spread betting you should be able to manage your own financial fate at least as well as the so-called professionals.

For me, the convenience of the available tools and the tax arrangement vastly outweighs any advantage that even a good broker would offer. And (for me personally) it is even better than direct access shares dealing.

How risky is it?

All trading and investment carries risk, with some investment products carrying a higher degree of risk than others. Financial spread bettings rests at the higher end of the risk balance in that, in the worst case scenario, your losses are theoretically uncapped but in practice the risk can be controlled through the use of stops and sensible risk management. In fact, you shouldn't get involved in day trading or other short-term trading products unless you are willing to follow some simple rules of common sense.

When first starting out, it is good practice to start small and limit yourself to dealing in just a few markets. Also, it is sensible to tie in guaranteed stops to your trades, irrespective of the cost premium particularly if you are trying your hand at shorting or trading unfamiliar markets. In some situations, without the additional protection that guaranteed stops provide, there is a risk that your potential loss is unlimited. Also, it is important that you research the company or other market you are going to trade. You should aim to become an expert in your chosen sector. But more importantly make sure that you use your own judgement to open or close trades, as opposed to relying on 'hot tips'.

Make sure to monitor your positions while they remain open - news travels quickly and the markets can move rapidly meaning that events can have a dramatic effect on open trades. Always be prepared to cut losing positions without allowing your emotions to interfere. If you follow these simple rules you can reduce your downside side substantially.

The main problem with spread betting is that people see how quickly money can be made, they get a taste of it and imagine an easy life, trading for a living and being a big swinging dick, the reality is that it takes hours sitting in front of a monitor and is on the whole pretty soul destroying when you are not in a winning position.

Is it for you?

Not everyone should use this trading product. Spread betting does demand a degree of discipline and courage, as well as the capacity to accept that you can't always be right and that losses are part of the business. Being emotionally detached is absolutely essential if you want to continue computing dispassionately the chances of wins or losses as circumstances change at speed.

How do you get started?

You need to open a spread betting account. Usually, the providers will ask you to make a deposit - normally an amount around £1,000.

Remember that dealers are not there to give you advice; you are expected to know what you are doing although they will normally try to help those who tell them that they are beginners. Do also keep in mind that telephone conversations with dealers are recorded to avoid misunderstandings.

>> Next Page - The Value of Gearing vs Buying Shares

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