Whenever I am asked by friends and family about what I do, it is surprising how often they will come to their own conclusion when I mention spread betting: “Ah, you are a professional gambler”. This point of view is justified and with good reason: most spread bettors lose. Simply put, an average investor is very poor at timing the market.
I suppose this series of articles is a reply to the accusation that I gamble for a living (well, for a second income at any rate) and that stock markets are nothing more than enormous casinos.
This post is part 1 in a series that I hope will answer in depth the question: ‘What is spread betting?’
There are two main forms of spread betting in the UK:
Sports spread betting, as you would imagine, is all about making bets on sporting events. (I have never placed a sports spread bet because I would be gambling; I know nothing about form or how the weather may effect outcomes).
Financial spread betting refers to spread bets placed on stock, currency and commodity markets around the world. Usually, you are able to open spread bets on all of these markets from one online trading account.
For example my spread betting provider allows me to trade currency pairs, stock indices, shares, commodities, options, interest rates, sectors, house prices, as well as bespoke bets based on the financial markets. Put simply, financial spread betting is a means by which private investors and traders can participate in the global financial markets.
When you spreadbet on a company’s stock price, you are in fact speculating that their share price will rise or fall. The more the stock price rises or falls in line with your spread bet, the more money you make (or lose if the market goes against you)
Why the Bad Reputation?
Most spread bettors lose. Its a fact.
There is a well known statistic that has been doing the rounds in the trading community for years and it is this: more than 80% of people lose money on the stock market. This statistic is not exclusive to spread bettors, it includes traditional share traders as well as highly paid fund and pension managers.
Added to this is the leveraged nature of spread betting. Spread betting providers permit you to gear up your position if you so want, so a certain amount of money can be made to go further than if you had bought or sold ordinary shares.
- This increases the potential gain you make from a correct market prediction, without having to put extra money in the account.
- However, this also dramatically increases the risk, since you can lose more than your initial deposit if your bet goes the wrong way.
Simply put, this means that losses (and winnings) are exacerbated when spread betting financial markets. So much so that it is entirely possible for a financial spread bettor to lose more money than is actually in their trading account.
This results from unchecked trading (trading without a trading plan) usually together with a desire to win (gambling), rather than a solid, thoroughly researched trade set up as part of a well designed trading plan that includes risk management as well as determining when to buy and sell.
How does a Spread Bet Work?
I spread bet UK shares.
If I were to trade them through a traditional online stockbroker, I would need to pay anywhere between £10 – £20 (GBP) per trade, plus stamp duty to the government currently (December 2011) at 0.5% as well as capital gains tax on any profits I made from the sale of the shares.
At the time of writing, spread betting does not carry any of these taxes and charges, including no capital gains tax on profits. Instead, there is only one charge called the spread.
Essentially, my spread betting firm quotes me a price based upon the real stock market price of all the companies listed on the London Stock Exchange.
For example, if a company was trading at £4.99 a share to buy, my spread betting firm would quote me slightly more, say at £5.00 per share to buy. The difference of 1 pence in this example would be my spread betting firm’s profit on my trade. Instead of charging me a £10 or £20 commission, they charge me a spread.
If the price of the company in the real stock market goes up to £5.50 a share to sell, then my spread betting firm would quote me approximately £5.49 to sell my spread bet; they again make money of the difference in the spread and I pocket the difference in price between my opening spread bet at £5.00 and closing it at £5.49, paying no commissions, no capital gains tax and no stamp duty.
Well I hope you found that useful, there is more to cover and I welcome your questions and comments.