Q: What are the Pros and Cons of using spread betting to trade?
A: As with any other trading instrument you have advantages and disadvantages -:
- Tax free for UK residents.
- The ability to go long and to go short.
- Simple price structure, no currency risk. You can trade the US indices in sterling giving you a defined return, even if the US$ weakens.
- Leveraged. Margin trading means that you can keep your capital tied up in other investments, without need to liquidate unless you suffer loss.
Because your transaction is a bet, your profits are free from UK capital gains tax and income tax. Also, in terms of trading on shares, because you are not physically buying a share when you trade, you are also free from stamp duty.
Disadvantages of Spread Betting
- Long positions charge a daily financing cost, working out at around 6%-9% per annum.
- You have to get the market direction right. For instance if you bought share in BP in Jan 10 they were just over £5.50, by March 10 they were £4. Today they are £5.88. It is difficult to tell when the peaks and troughs are in a market.
Like contracts for difference, spread betting derives from the future and options markets in the sense that you have at your disposal all the “joys” of trading on margin and going long or short on your position. Perhaps the key to understanding spread betting is to say that, unlike fixed odds bets where the stake and the potential losses or gains are known in advance, with spread betting the profits or losses are not known until after the fact. In simple terms it means that the more right you are in your judgement, the more you will make – and the obverse if you get it wrong.
Spread betting is very ‘open’ to access and trade, that’s its USP. The majority of the firms’ profits comes from those who play the markets sporadically and for ‘fun’…
Q: What are the secrets of spread betting?
A: Secrets? There are no secrets; all you need is a healthy dose of common sense.
If you do proper research and understand what you’re doing and manage your risk, you increase your possibilities of success. In fact with spread betting (actually for any style of day trading), being successful is more about managing and taking care of the risks as opposed to the reward on offer. If starting out you should bet small amounts and be disciplined with stops at all times.
In addition, the simplest strategies based on common sense usually work better. As with conventional stock market trading, there are no surefire ways to make money from financial spread betting, but there are some guaranteed ways to lose it!
Q: What is the catch?
A: Well, we know nobody gives you anything for free, likewise there are costs to spread betting. In economic terms spread betting is like going to the bank, borrowing some cash and using it to purchase some shares. In this situation the main cost is loan interest and the secondary cost the broker’s fees.
Therefore if you were investing by this method your main concern would be the level of loan interest (i.e. financing) and secondary concern the broker’s commission (i.e. the bid-offer spread).
Just like when you buy a share on a real stock market, there’s a difference between the buying price (the bid price) and the selling price (the offer price) – and the market will need to move in the direction you choose by the spread just for you to breakeven. The interest and commission in spread bets comes from the quoted spread and also the higher price paid for far-dated bets. The effective interest rate on spreadbets comes out something like 6%-9% per year (possibly even more) but it is quite difficult to get accurate figures.
Note: Sometimes I notice that on the smaller illiquid caps the spread betting quotes may go to ‘phone only’. I do think it’s fair to say that if a spread bet firm goes to phone dealing only; one of the possible reasons is that they are having trouble dealing the actual share themselves (that’s more or less what I was told on the phone anyway). And indeed phone dealing tends to happen when there is/will be action either way with the stock price – particularly with illiquid stocks.
We Say…
Obviously enough, we are very much in favour of spread betting as a form of trading. In terms of ease of use, access, relative costs and adaptability, it should provide one of the automatic starting points for any budding trader.
There are, of course, caveats. Like any form of trading, anyone getting started with spread betting has to be aware of what they stand to lose should the markets go against them, as they surely will at some point. But all of these amount to common sense. If there is one sure way to lose money trading, it is through going in blind. Avoid this, and you will be halfway there.
Once mastered, the trading basics will give you a platform. From there, it will be up to you. Many of the spread betting firms offer courses for those who want to know more. Meanwhile, there are many books and websites that offer more information for the intermediate spread better onwards.
All in all, spread betting can be an amazing way of building a portfolio as you only need to put down a small percentage of the full contract value to fund your overall position. This strength is itself a potential weakness if not managed properly as investors can quickly find themselves in a deep hole if they don’t know what they’re doing.
