Introduction

Wouldn't it be nice if you could make a quick gain by trading shares cheaply and without worrying about paying tax? Well you can. It's called financial spread betting! Even better this way you can also take advantage of both rising and falling markets.

Spread betting is a bit like Marmite, and not just because they both involve a spread. You love it or you hate it. Opponents of spread betting and its CFD cousin argue that there is something wrong with a product that does not involve investment in the underlying share. They feel it is a gamble and not an investment and that it robs the stock market of liquidity, although in the case of CFDs money finds its way into the market via hedging. Supporters of spread betting point to the flexibility that it offers investors and traders by allowing them to go short (sell) or long (buy) and to put money on a wide range of assets and markets. Perhaps more importantly, there is no stamp duty to pay and no tax on capital gains.

On the last point, it is a source of absolute amazement to me that a government and chancellor who have been so diligent in imposing stealth taxes should have allowed the tax discrepancy to continue unchallenged.

True, if the Inland Revenue wanted to get nasty it could make life miserable for frequent traders, but so far this doesn't seem to be a bullet it wishes to bite.

Conventional wisdom has it that in a falling or 'bear' market only the brave, the mad or those with inside information will wish to buy and sell shares. The monthly figures from the IMA (Investment Managers' Association) and APCIMS (the Association of Private Client Investment Managers and Stockbrokers) do much to support this view. They indicate that trading volumes in ordinary shares and collective equity vehicles by private clients have dropped dramatically since the heady days of the dot.com revolution.

However, in the kind of volatile markets that we have encountered in the past three or four years, spread betting provides opportunities for individuals to prosper irrespective of the direction the indices decide to take.

"When the markets were heading south, uk spread betting became the instrument of choice for private investors," says Brian Griffin, chief dealer at CMC Markets. "As the markets began turning the corner, there was genuine speculation that the party would end. To the contrary, spread betting figures have soared as investors take advantage of the tight spreads and commission-free aspects of the product to capitalise on the small but significant price movements in the underlying markets."

Now, of course, spread betting is not without risk. Like any other investment, individuals can lose money. But, whilst, to most, the title 'spread betting' will immediately conjure up an image of straight-forward gambling, some would argue that the risk profile is entirely different from a wager on the three o'clock race at Newmarket.

Origins

Financial spread betting is a relatively new method of trading the markets. Originally only considered a 'City activity' and prior to 1999 only two companies offered spread betting. Then it steadily grew in popularity and more recently has exploded with the number of investors placing spread bets trebling in just one year. The public's access and familiarity with computers sparked this off and the spread betting companies then really grasped the nettle around 2003 and began to rebuild and refine their websites to be more user friendly as well as providing a more comprehensive on-line service. We have also seen more and more companies offering spread betting in recent years.

Spread betting is also simple in concept so that people who have not traded the markets before can easily grasp it and trade without fear of showing themselves up by talking to an experienced trader or broker on the other end of the phone line. It is self-contained in that you can pretty much do everything from your armchair at home or your laptop when travelling.

You can open a trade in seconds with a couple of clicks of the mouse and you can close trades just as easily. You can trade in VERY small amounts until you gain confidence and all of this with no fear of a broker sniggering behind his hand because of your apparent lack of knowledge. What am I saying, of course brokers would never snigger, would they?

Interestingly, it appears that a small but growing band of enthusiasts have picked up on this and, far from being daunted by market volatility, are plunging head-long into active market spread bets on a daily basis. They are using this facility as a tool to make money in both rising and falling markets. Indications from the major spread betting firms are that there are now over 400,000 spread betters and this number is continuing to rise.

It doesn't stop with new traders either. I know of very experienced active traders who have traded the markets for 20 years or more who have now switched completely to spread betting.

What Spread Betting is - and isn't

The type of betting you are probably most familiar with is rather different from financial spread betting. In normal betting, you are taking a view on a horse race or a football game and are looking for a particular result. But in financial spread betting, the bet that you are making is not this fixed result, a single moment in time. You don't 'bet' that BP shares will hit 439p on 28 January, for example. Instead, you place a bet on whether you think a share or a market will be higher or lower in a few months than it is today.

Spread betting should be regarded simply as a way of backing your view on where the financial markets are going. Like anything else, the more you get it right the more money you make. But it is not a game. If you are wrong you will lose real money.

So what are the reasons for this? Well, paradoxically, market volatility, the historic enemy of many private investors, is actually encouraging daily bets on share-price movements. The fact is that share-price falls are as much of an incentive to place a bet as their potential to rise.

About leverage and margin: 'I'm minded of the legendary Sir John Templeton, who if I recall correctly bought the 100 cheapest US shares at outbreak of World War II, without doing any analysis whatsoever - and on margin! Dozens went bankrupt, yet he made big gains overall.' Obviously we remember him because it worked (survivorship bias, beware!) but still...

How Spread Betting has revolutionised the market

Spread betting was first offered by Stuart Wheeler in 1974 when IG Index opened its first market on the gold price. As with share futures, clients were able to bet on where they saw the gold price going in the future. This product took off rapidly and soon spread to the financial world. In 1985, IG Index offered its first financial spread bet on the FTSE 100 index. The rest, as they say, is history. And now you too can use spread betting to maximise your gains.

These days most spread bets are placed online although telephone dealing is still provided at most companies. Mobile trading is also becoming increasingly popular.

⇑ ⇑ ⇑ ⇑ Listen to our Introduction of Financial Spread Betting.

How does Spread Betting Work?

The explanation text that follows is intended to help you understand the points referenced in the podcast above.

The FTSE 100 Index is currently being quoted: 5775 - 5776.
If you believe the index is going to go up, you buy, if you think it is going to go down, you sell.

Profitable Trade

If you believe the index is going to go up, you would buy at the high end of the bid-offer spread - in this case 5776.
You buy at £1 a point at 5776.
At some point later on in the trading day the price has gone up 10pts: 5785 - 5786.
You want to close the bet so you sell £1 at 5785 (lowest quoted price).
5785 - 5776 = 9pts.
Profit = £1 (Stake) x 9pts = £9

Losing Trade

Bought at 5776.
Later on in the trading day, the FTSE has gone down by 10pts and you think the downtrend will continue so you want to cut your losses short.
The spread is now: 5765 - 5766.
In this case you can sell at 5765.
5776 - 5765.
Loss = £1 (Stake) x 11pts = £11

Forex Example

EUR/USD: 1.4039 - 1.4040.
If you treat it as 14039 - 14040 it makes it easier to understand (1pts spread)

EUR/JPY 80.47 - 80.49.
8047 - 8049 is equivalent to a spread of 2pts.

Interactive Online Spread Betting Trading Simulator

Check out our interactive online spread betting simulator supplied to us courtesy of Capital Spreads. Learn how online spread betting works using our interactive trading tutorial to place a simulated trade. Click the Start button to get going, chose your market and stake size and see how the market movements affect your potential gains or losses.

Spread Betting Example: FTSE 100

If we look at the general levels of the FTSE 100 today, a typical scenario such as this will occur. A call is made to the spread betting firm to ask for its 'spread' on the FTSE 100 (spreads can also be viewed online at the websites listed below). Typically, today, this might be 4050-4250 (4250 to place a 'buy' or 'up' bet and 4050 for a 'sell' or 'down' bet).

If you believe that the FTSE 100 is going to rise, you would place an 'up' or 'buy' bet. You could, for instance, buy 10 [pounds sterling] per point at 4250. If the FTSE 100 then rose to 4430 within a specific period, you would earn a profit of 1,800 [pounds sterling], which equates to 10 [pounds sterling] x 180 (the points rise in the index). Alternatively, if the FTSE 100 falls to a level of 4070 during that same specified period, you would lose 1,800 [pounds sterling] (again 10 [pounds sterling] x 180).

If you hold a negative view on the prospects of the FTSE 100, you would place a 'down' or 'sell' bet. Using the same example, you would bet 10 [pounds sterling] per point at 4050. If the FTSE 100 falls to 3870, you make a profit of 1,800 [pounds sterling] (10 [pounds sterling] x 180) but on the other hand if the FTSE 100 rises to 4230, you lose 1,800 [pounds sterling] (10 [pounds sterling] x 180).

You can see from this example that spread betting offers a very simple mechanism for individuals to bet on the movement of markets. Historically, the only way an individual investor could benefit from a falling market was by selling shares 'short' or maybe by investing in hedge funds. Spread betting is a means of solving this dilemma.

The process of opening an account is straightforward, whether it be an online or a telephone account. Investors can hold a 'credit' account, where funds are deposited with your chosen spread betting firm, in your own designated account, and winnings or losses are added to or taken out of this account. A 'debit' account is where the investor provides credit or debit card details. The maximum agreed potential loss is taken out, up front, and winnings then credited back to the investor. Accounts may be closed at any time.

Interest will be added (usually monthly) on all funds held on deposit, and every account holder will be sent regular statements (usually daily) in an effort by the industry not only to meet but to surpass FSA regulatory requirements. The spread betting industry is fully regulated and supervised, and all client accounts are segregated from those of the firm with which you are undertaking transactions.

While this article has outlined the practicalities of a simple spread bet on one of the financial indices, there are in fact a wealth of different opportunities for the private investor to consider. These range from individual shares to currencies, property, politics (how much would an astute bet have made on the recent by-election result in Brent East?) and particularly sport. This is possibly the fastest-growing area of the industry, and, despite unsubstantiated reports and stories of footballers scoring own-goals at a specified time to clean up on a particular bet, sport by its nature is wondertally unpredictable and therefore a perfect setting to allow the spread betting industry to expand.

With no taxes, no paperwork, no stamp duty, and no commission, spread betting is booming in the present market turmoil. Allowing punters to bet on the rise, or significantly the fall, of currencies, markets, stocks, shares, options and commodities over a range of outcomes and along a defined timescale, spread betting remains on the up.

In Summary

Whatever your feelings towards gambling, spread betting is here to stay. If you wish to be involved then, just as with any other form of investment, never forget the basics. Do not over-commit yourself in any one transaction. Ensure you have researched and understood, fully, the spread bet you are going to make. Look to limit your losses if markets or events move against the bet you have made. Make sure you are conversant with the principles of leverage (or gearing)--it is this factor that amplifies both your gains and your losses.

Despite the potential rewards, financial spreads betting is likely to remain a 'Cinderella' sector for the majority of private investors.

For the majority of investors, ultimately, the conclusion will be to stick with what they know best, i.e. traditional equity investment into a share or collective equity fund. In that way individuals will more fully comprehend the nature of their investment risk.

For the minority, however, who enjoy their weekly flutter on the National Lottery or annual visit to the Grand National or Epsom Derby, the potential exists to create a hedge against your general investment decisions being wrong and having some fun by creating the opportunity to make above-average gains (and losses!).

>> Next Page - The Facts about Spread Betting

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