Spreadbetting is most easily explained through an example – the concept is the same whatever the market. Imagine that in early August you believed the FTSE 100 index’s value of around 6230 was too high and that share prices would fall over the following month or so. Accordingly, to spreadbet City Index for a quote – it gave you a FTSE 100 price for the third week of September of 6165-6175. Based on that spread, you had two choices. You could have bet on the Footsie falling below this level, by selling the index. Or you could have bet it would be higher than this in September, by buying the index. Either way, you bet by staking a sum, say £10, per point. As you expected the Footsie to fall, you took the former option. Now imagine that on 17 September, the FTSE 100 actually closes at 6020, 145 points below the City Index spread. On this basis, your profit would be £1,450 – 145 times your £10 stake. In fact, you do not have to wait until 17 September to book your profits. Gamblers can close their bets as soon as they become profitable. If the index had stood at 6050, say, on 1 September, you could have closed out your bet by reversing it – buying points from CityIndex.
However, the downside of spreadbetting is that the potential for large gains is equalled by that for large losses. Imagine that you had bought, rather than sold, points from City Index in the example above. Your loss would have been a nasty £1,550 – £10 times the 155 points the Footsie finished below your opening spread. It is important to note that in spreadbetting gains and losses are geared. The more right you get a bet, the more you win. But the more wrong you are, the greater your losses.
Not surprisingly, spreadbetting companies are wary about bad debts. They will only extend credit to investors who can meet any losses. Expect calls for cash from your bookmaker if your bets move into the red. On the other hand, all the firms say that, unlike conventional bookmakers, they do not lose on winning bets, as they lay off risks in the underlying markets. Spreadbetting firms, therefore, do not mind successful gamblers.
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So how does it work with these bets? It’s quite simple; you take an index, a stock or anything that is listed by the spread bet provider. You place a bet of say £1 that the price of the index or stock you have selected goes up or down (up-bets and down-bets, respectively). If the price goes with your bet then you earn £1 for each point (or pip as they call it) or you lose £1 for each pip that the price goes the opposite way.
Further Examples of how SpreadBetting Works
Example one
- The FTSE 100 market is quoted as follows: 5600-5602
- It is possible to buy at 5602 (the offer price) or sell at 5600 (the bid price)
- The investor believes the price will go higher than 5602 and bets £2 per point
- Their expectation is correct and they choose to sell at 5642
- They can then claim £80 (40 * £2 per point)
Example two
- The FTSE 100 market is quoted as follows: 5600-5602
- It is possible to buy at 5602 (the offer price) or sell at 5600 (the bid price)
- The investor thinks the price will go lower than 5602 and bets £1 per point
- Their expectation is wrong and you decide to sell at 5622
- They would lose money as 5622-5602= -20 * £1 per point = loss of £20
Remember: Indexes have been known, on occasion, to move by hundreds of points at a time. For example, in May 2010 the DOW fell over 950 points in what become known as the Dow Jones ‘flash crash’ and in June 2010, the DAX rose by more than 300 points in several days.
The range of trades available through spread betting has also mushroomed over the last two years. Most providers for example, now offer spread betting on at least 40 global stock market indices and a multitude of currencies and commodities. Investors can also bet on the individual share prices of the largest 350 companies in the UK. Most providers also offer downside protection, allowing investors to specify how much they are prepared to lose on any bet. Some providers even also offer guaranteed stops which will automatically close out your bets if the market moves against you by more than a pre-determined amount. This risk management service costs a little extra, but is a useful facility given the potential for large losses in spread betting.
Nevertheless, spreadbetting is not simply for short-term gamblers. In particular, it can be a useful tax planning tool and is ideal for investors who want to hedge the risks they face on their actual portfolios. Imagine, for example, an investor with a large portfolio of shares who is convinced that the market is about to collapse. One option would be to sell his portfolio and move into cash, but this might trigger a sizeable capital gains tax bill. The alternative is to sell points on the Footsie or the All-Share with a spread betting firm. If the investor’s view is right, his portfolio losses will be matched by gains in his spread betting account.
Tips
- As with most things involving a risk, the savvy people will ensure they are fully prepared, so that if the worst does occur they are not badly hurt. This makes it important to research the products you wish to trade and take full consideration of the risks associated with this sort of investment. Although a vast experience is not required to spread bet, being as well informed as possible is always a good idea.
- Try using technical analysis to help with your investment choice – this is offered by virtually all spread betting firms. Making use of charts and technical tools is a wise idea and it is best to discover who offers the services required. If such indicators predicted the markets to fall, you can instruct your broker to ‘sell’ the FTSE. The same is true if signals suggest a summit point of profit is likely to be reached.
- Some strategies are more popular than others and you might like to find out more about market trends, scalping, break-outs and reversals before parting with your cash.
Provided you are fully aware of the risks, spread betting offers several advantages. One major attraction is the ability to magnify returns. A spread betting customer can capture a much bigger return on funds as a percentage of initial outlay. A pounds 10 bet on a UK share offers the equivalent market exposure to holding 1,000 shares in that company, irrespective of the actual price of the shares.
For example, if you placed a pounds 10 spread bet on Marks & Spencer shares, you would make a profit of approximately pounds 10 for every 1p the share price gained (or lose pounds 10 for every 1p it fell). If you were to buy 1,000 M&S shares at the current price of about 360p, you would have to cough up pounds 3,700, plus commission and stamp duty. So the initial outlay on a spread bet would be far less to achieve the same potential outcome.
Simon Denham, the managing director at a spread betting provider, says: ‘It’s generally considered that about 80 per cent of bets lose, a level comparable with the experiences of private traders on the various worldwide futures exchanges. However, of the 20 per cent that win, some make very high returns on their money.’ Denham adds: ‘A common problem is that the small deposits required to run positions often tempt clients into taking bigger positions than they would otherwise do when trading in the real shares.’
A further advantage is that — unlike traditional shares, commodity or index-based investing, where profits rely on upward price movements — you can benefit from falls with spread betting. You can, for example, bet that a share price will fall, or that the gold or oil price will drop.
And because spread betting is regarded as gambling, you do not pay stamp duty on bets and any gains are tax-free. The flip side is that you cannot offset losses against tax.
The most popular targets for spread betters are the major indices such as the FTSE100, the Dow Jones and the Nasdaq. The top 50 shares in the UK market are also popular among UK enthusiasts. More recently, the gold price and dollar movements have attracted strong interest.
It is easy to start a spread betting account. You sign up online and open an account with a debit or credit card. Provided the spread betting firm can verify your identity, you could be up and running in as little as 10 minutes.
