If you’re new to financial spread betting and are looking for a guide, or just the benefit of someone else’s experience, we have asked an expert to give his thoughts from a beginner’s perspective. Getting started in spread betting can be daunting but we hope to help you along the way.
With spread betting you can go long or short on thousands of markets, including shares, forex, indices and commodities. And any profits you make are tax-free.
In this section, we examine the nuts and bolts of spread betting, an alternative speculative tool for investors and traders to the conventional markets in shares and other financial instruments. Spread betting is all about working out for instance where a share market stock or index will finish the day compared with where it opened. It is not limited to stocks and indices either; you can spreadbet on shifts in the prices of cattle, cocoa, hogs, oil, gold, oats, soya beans, lumber and heating oil…etc.
There are a number of factors that make spread betting distinctly different to other forms of trading, such as:
- The chance to profit from the price movements of a particular market/s without having to purchase the physical asset.
- The opportunity to profit from both rising and falling markets.
- The ability to trade on margin, allowing you to take an immediate position with only a small portion of its total value – sometimes as low as 0.5%.
As a derivatives financial product, you trade on prices that mirror live market price movements without actually owning the underlying financial instrument on which the contract you are speculating on is based. In addition, since spreadbets are a leveraged product, investors are only required to deposit a small amount which only makes up a small fraction of the market position value. You buy at the top of the spread and sell at the bottom, if you are going long (betting on it going up), and you buy at the bottom and sell at the top if you are going short (betting on it going down).
It is important that you understand the key features of spreadbetting before you decide whether or not to risk your money. Spreadbetting is traded on margin which in practice means that you do not have to pay the full market price of the underlying shares. You only have to put sufficient funds in your trading account to cover the margin to open the position. Therefore, you might only need to deposit £1,000 as initial margin to enter into spread trading positions up to a value, of say, £10,000. If your speculative investment rises to £12,000 – which amounts to a 20% rise in the value of your position – you will in fact stand to make a 200% return on your investment, as you only deposited £1,000 initially. However, this leverage also increases the risk; as you do not actually own the underlying instrument, you could incur losses that exceed your initial deposit if the market moves against you which is why risk management is so important.
Workings of Spread Betting
Spread betting firms offer a quote, which consists of a bid (selling) price and a slightly higher, offer (buying) price. If the FTSE 100 stands at 4,700, the spread betting provider may provide a bid price of 4,698 and an offer price of 4,702. If the client thinks that the index will rise, they ‘buy’ for £10/point at 4,702. If the FTSE rises to 4,724 by the day’s close, the profit will be £200 (4,722-4,702 x £10). As clients’ positions change quickly, spread betting firms demand some protection that they will be paid. This is a deposit called ‘margin’. If losses threaten to exceed the margin, the provider will demand more money, known as a margin call, non-payment of which lead the provider to close out the position. An alternative way to limit the risk is to use stop losses. These are orders to close out a trade at a specified level although there is a potential problem with ‘gapping’. Where the market is moving fast and lots of stop-loss orders are triggered together, they all close at the market price closest to the specified price on a first-come, first-served basis, so the customer may not get out at the level they expected.
Tax efficient ways to make money…
Spread trading is a capital efficient investment product that allows you to speculate on the stock markets. You can also utilise spreadbetting to diversify or hedge your portfolio, because spread bets require only a margin deposit to open a trade as opposed to the full cost of the underlying market exposure. You can release capital tied up in shares positions or open new positions that are long or short.
Go Long or Short
An important feature of spreadbetting is that you can enter both ‘long’ or ‘short’ trades. A “long” position involves purchasing the contracts and selling them again at a later stage, hopefully after the price has risen. So in essence, ‘long’ positions make money in a rising market.
A ‘short’ trade is the opposite – selling contracts first and buying them back later. This may sound strange but in practice you can make money in the markets by either ‘buying low and selling higher’ or by ‘selling high and buying lower’. If you manage to buy them back at a lower price, you will make money. Therefore ‘short’ trades make money in a falling market.
Spreadbets are very powerful trading tools that will benefit active traders and investors who are looking to optimise their cash flow and benefit disproportionately from small market movements. Equally, spreadbetting can also be utilised as a cost-effective hedging mechanism that allows you to exploit market movement whilst benefiting from corporate actions. Short positions allow you to make money even in a falling market.
It is sometimes said that trading stocks is nothing more than glorified gambling. Well, financial spread betting doesn’t even try to refute this claim, offering a vast range of areas in which punters can gamble to their hearts’ content!
Financial spread betting can be exciting and rewarding – in fact spread betting being a leveraged trading product means that it is a very powerful financial tool in the hands of the wary. If you are in the USA, you may not be so familiar with this derivative, as you don’t have the tax advantages that are enjoyed in the UK. In the USA, you are more likely to leverage your investment with options or futures, and these give you a similar way of multiplying your investment with a small outlay.
A word about ‘derivative’. It sounds complicated, but really it’s not. A derivative is a financial instrument that is derived from something else, for example from a share price or an index. It just means that you don’t actually own the share, but win or lose according to the rules by how much the share price changes. Spread betting allows investors and traders to bet on whatever you believe a financial market or share, will do. The more the market moves in your favour, the more you stand to gain; but the more it moves against you, the more you could lose – and you may lose much more than your initial deposit. Spread bets are traded with leverage which means potential to magnify trading gains dramatically. But of course, when you open the possibility of large gains you also take on the possibility of large losses if you get it wrong, although there are ways to limit your potential losses, by ‘hedging’ your trade. The whole point of my training is that you learn to get it right as often as possible, and learn to minimize your losses if things don’t go the right way.
Spread betting counts, as you might expect, as a bet, and as betting proceeds are not taxed in the UK, becomes a way to profit more than by buying and selling shares, where the capital gains are taxed. Additionally, as mentioned, it leverages your investment. The ‘spread’ in stocks is the difference between the quoted buy and sell prices for the product, and is where the profit is made for the dealer. The interesting thing for the UK and European trader is that you can bet ‘short’ as easily as you can bet ‘long’ with the product, and that isn’t always so easy in Europe. In the USA, you are more readily able to go short, although you do have to wait for an uptick in the price before being allowed to, unless you are trading ETFs, which can be bought for either direction of movement.
As Robbie Burns say, a key point to being able to trade full time is the ability to play both sides of the market: i.e. to go ‘long’ and ‘short’. The thing is if you can go short when the market is falling you can make money just the same as if it was going up. Also, shorting gives you the courage to perhaps hold on to long-term good strong companies, saving the costs of commission for selling and buying.
Spread Betting: The Individual Investor’s Most Powerful Profit-Making Tool
Spread betting is a gift from the Gods. In recent years financial spread betting has exploded in popularity as an alternative investment tool due to the leverage that it provides and the tax treatment of gains since all profits are currently free from stamp duty or capital gains tax.