Introduction to financial Spread Betting
Financial spread betting is a cost effective, tax free* alternative to traditional share trading.
Unlike traditional share trading, investors can easily trade a wide range of instruments including:
- Commodities such as oil or gold
- Foreign currencies
- Indices such as the FTSE
- International shares like Google and Nokia, and many, many more.
And unlike traditional share trading, it is possible to make a profit in both rising and falling markets.
A financial spread bet allows an investor to bet on whether the price for a given financial instrument is likely to go up in value (strengthen) or go down in value (weaken). Just like traditional share trading, your profit or loss is the difference between the price at which you buy and the price at which you sell. Buy low and sell high to make money.
Unlike traditional share dealing where you purchase ownership of the company, spread betting means that investors don’t own the physical share, but bet solely on price movements. This gives investors the opportunity to profit whether the markets are rising or falling. If you get the market direction right then you make profits but if you get the market direction wrong it means you make losses.
In the stockmarket, when you want to deal in traditional shares, you go to a stockbroker who will quote you two prices – the price you can buy at (the ‘offer’ price) and the price you can sell at (the ‘bid’ price). In spread betting, the principle is exactly the same, two quoted prices, bid and offer.
If you believe the share (or index, commodity or other market) will go up, you buy at the offer price - the higher of the two prices quoted. If you believe the share is going to go down your bet will start at the bid price - the lower of the two figures.
When you place your bet you will be asked to say how much you want to bet on a per point or per penny basis. For example, if you were betting on a UK share at £10 per point you stand to win, or lose, £10 for each penny the UK share price changes. This bet stands until you choose to close it.
Background and History
Financial spread betting dates back to 1974, created specifically to enable people to trade the price of gold at a time when exchange controls prevented buying the metal itself without paying a hefty premium.
In the year 2000, new companies began competing with the established players, and as the number of companies in the sector have grown, so too has the range and types of bet offered.
There are now more than 75,000 spread betting accounts alone in the UK. The flexibility and cost effectiveness of financial spread betting offers a number of benefits over and above that of trading other financial instruments.
Methods and means of spread betting are changing too. Spread betting platforms such as Marketmaker:Investor Edition now offer 24-hour dealing and live internet trading. There are new and improved credit facilities available, and we now offer the option of limiting risk or guaranteed stop losses while keeping the potential rewards unlimited.
Spread Betting Advantages and Disadvantages
Advantages
- Ability to trade a wide range of markets
Spread bets are offered on thousands of instruments including Shares, Indices, Sectors, Commodities and Treasuries. You can trade on all of the top UK stocks and some of the more popular small cap stocks as well as all major indices in the UK and overseas. This gives you easy access to popular instruments like Oil, Gold, Google, Sony, Volkswagon, the S&P 500, the dollar and much more. Many of these instruments either cannot be traded or are very difficult to access through traditional share trading. - Trade on Margin
This is also known as gearing or leverage. When buying shares in a company an investor must pay the full purchase price, so 1,000 shares for 250p would cost £2,500. When using a spread bet the client is able to create that same exposure but pay less cash. Typically the margin is 5%, so to open a position worth £2,500 the client only needs to pay £125 up front.
This means that you only have to allocate a small proportion of the total value of your position to secure a trade, while maintaining economic exposure to the relevant underlying instrument. This magnifies the profits against the initial outlay. - Make money when the market falls
With spread bets you are not actually buying or selling shares at all, you are only making a bet on which direction the share price will move. This means that you can ‘go short’ or bet on the price of shares falling.
In traditional investing, private investors are not able to go short as you cannot sell something you do not own. Some brokers will make exceptions for extremely wealthy clients and for very few shares, but in general the only way to make money with traditional investing is for share prices to rise. This means that in difficult market conditions, traditional investors will be more likely to lose. With spread betting it is equally easy to go short or go long across the full range of markets and instruments. - Costs
Spread bets are commission free, so are cheaper than traditional share trading. The added plus of needing no middleman means you will save time and money. - No Capital Gains Tax or stamp duty*
Profits from spread bets are not typically taxed as capital gains. Spread bets are also free from stamp duty.
Disadvantages
- Trade on Margin
Also known as gearing or leverage, trading on margin is a double-edged sword. With shares, the worst that can happen to your £5,000 investment is that you lose the lot. With £5,000 of spread bets, your potential losses are not limited to your 5% initial margin of £250. Since £250 can give you exposure to a trade worth £5,000, if you use your entire capital to open up trades then your initial £5,000 can give you exposure to trades worth £100,000. However, a sensible stop loss policy or limited risk accounts enable you to limit any losses. - Tax cannot be offset
Although spread bets are free of UK Capital Gains Tax losses cannot be offset against capital gains you may have made from traditional share trading or other investment activities. - No perks
You don't pick up the perks of actually owning the shares; you are not entitled to vote or attend company meetings. However, with online share trading, most investors will hold ‘nominee’ accounts which also don’t entitle them to any perks. For anyone who is already trading shares online, this limitation of spread betting goes largely unnoticed.
Spread Betting Example
The best way to explain how Spread Betting works is through an example, but before we get started, read these three quick definitions that will be helpful in the example:
Margin – the fractional amount of the trade value required as a deposit
Financing charge – the fee you are required to pay for trading on margin
Libor – the base interest rate that banks receive
- ABC Corp. is trading at 1.59/1.60 and you think the price is going to rise in value.
- You decide to place a buy bet so you buy ABC Corp. at 1.60
- Since you are new to spread betting you trade the minimum amount of £1 per point. The value of your position will £1 per point x 160 points = £160.
- Let’s say that your margin requirement for ABC Corp. is 5% therefore £8 (5% of £160) will be allocated from your account against this trade as initial margin. Remember if the share price moves against you, it is possible to lose more than this £8 initial margin.
- You place a buy bet at 1.60 on ABC Corp. at £1 per point.
- Two days later you see that ABC Corp. has risen to 1.85/1.86. Therefore you choose to sell at 1.85 and realise your profit.
- You bought at 1.60 and sold at 1.85 which means ABC Corp. rose by 25 points. 25 points x £1 per point = £25 profit. If the market had moved against you and you sold ABC corp. at 1.35, then you would have incurred a £25 loss.
- You held the position for two days which means you incurred two nights’ financing charge. This is how you calculate the financing charge; £160 (value of the position) x Libor + 3% (which for this example = 8%) /365 (number of days in the year) x 2 (number of days position is held)= 7p
- Therefore you deduct the financing from the total revenue and realise a profit of £24.93, all from an initial outlay of only £8. Remember, if the market had moved against you then you would have incurred a loss of £25.07 (£25 loss +7p financing = £25.07), which is more than the initial £8 outlay.
Top Tips
Be disciplined. There's a saying in the business: Plan your trade and trade your plan. Whatever trading system you use - pick one that doesn't stretch your personal stress levels - make sure you stick to it. There should be no exceptions to your rules. Marketmaker:Investor Edition provides you with all the research and analysis tools you need to work your plan.
Admit mistakes. You are bound to make wrong calls occasionally. When it happens, don't dither. You will have a rule that says cut losses, so do it. Remember, nobody is perfect and all trades cannot be winners. Always look at the bigger picture. This will be important when cutting your losses, although stop losses may help with this immensely.
Use your own money. Never borrow to bet. Only trade with money you can afford to lose.
Know the product. Research and understand the volatility (range of price movement) of the instrument you are dealing in.
Sleep well. If you lie awake at night worrying about a bet you are going to make, don't do it. If you are wakefully worrying about a bet you have already made, don't do it again.
Next steps
The actual process of placing your first bet could not be more simple. You will first need to open a spread betting account; Marketmaker:Investor Edition – built by CMC Markets and Digital Look – combines the powerful trading platform of one of the leading Spread Betting providers with the deep content, data, tools and information you know and love from Digital Look.
Once your account is open, CMC Markets can provide you with hands on training, free educational seminars, online guides and a highly trained customer service team to help you on your way.
Alternatively, you can attend a free spread betting seminars or a low-cost workshop, where you can see Marketmaker:Investor Edition working in practice. Find out more at www.digitallook.com/events.
