The Advantages and the Risks
The Advantages of Spread Betting
Financial spread betting can be highly lucrative and is an ideal trading style for anyone looking to expand their trading portfolio into a wider range of financial instruments without making a significant investment. However, as with any type of trading or investment, there are both advantages and drawbacks, which you need to be aware of before you start trading.
In practice there are many advantages to spread betting versus traditional methods of trading. Listed below are some of the reasons why spread betting has become so popular.
- Easier to understand compared to other financial instruments
- Can be traded from short term to longer term positions
- Profit from rising and falling markets
- Start with a small amount of capital
- Trade on margin (You only pay only a fraction of the full cost of the trade)
- No commissions to pay
- No stamp duty on UK shares
- Access to a wide range of markets
- Only one account required for a wide range of markets
- Minimum paperwork compared to share dealing
- Instant execution
- Extended trading hours
- Telephone or online dealing
- Unlimited profits with limited losses (Use of guaranteed stop orders)
- All profits are 100% tax free **
Spread betting allows traders to deal in a wide range of financial instruments from a single account. These include equities, stock indices, currencies, commodities, interest rates, options and futures. Obviously with a good trading strategy coupled with great risk management rules you can make a lot of money with spread betting from relatively small amounts of capital.
Probably one of the the biggest advantages to spread betting is the fact that it is easier to understand that any other financial instrument and the entire process is much simpler than trading options, futures or CFDs. Additionally, the capital requirement is relatively low as you can open an account with a deposit lower than £100.
Spread betting also allows margin trading and you only have to pay approximately 10% of the total cost of your trade up front. It also allows traders to profit from both rising and falling markets. Likewise, spread betting companies do not charge commissions as their revenue is built into the spread between the bid and ask price.
As a trader you also have a wide range of spread betting companies to choose from, some of which are open 24 hours a day compared to normal market hours which run from 7:00 to 21:00. Additionally, spread betting companies offer their clients access to a wide range of information including investment research and market commentary that is only usually available to large volume traders and financial institutions.
The main benefit (in the UK) is that Spread Betting it is TAX FREE. There is no stamp duty to pay on each transaction and there is also no income tax to pay on your profits. This is because it is classed as a form of gambling and any gains made from gambling are considered tax-free by Her Majesty’s Revenue and Customs. Conversely, if you were to trade shares or any other financial instrument traditionally your gains could be taxed according to your current income tax rate. That means you can win £1 million and the tax man does not see a penny of it.
You will also save money on stamp duty, which is currently equal to 0.5% of the size of your share purchase. While this may not seem like much, if you trade regularly, the savings can add up.
PROFIT FROM PRICES GOING UP, GOING DOWN & GOING SIDEWAYS
Unlike traditional trading you have the ability to make money on whether a market will go up, go down or even go sideways. This allows much greater flexibility and gives you the advantage to make money whatever the current economic situation.
There are no broker commissions. As you are not physically buying and selling the underlying stock you do not pay a broker to trade it for you.
LESS CAPITAL NEEDED
Due to Gearing or Leveraging you can use smaller amounts of money to trade with without tying up large amounts of your savings or capital.
WIDE RANGE OF MARKETS IN ONE PLACE
You can trade stocks, bonds, commodities, indices, forex etc all in one place when you are spread trading. One minute you could be trading Gold then switch and trade the the Forex all from within one trading account.
As you can see the benefits for spread betting are considerable and certainly advantageous compared to many other forms of trading.
I hope this gives you a flavour of the ups and the downs associated with spread betting. If you have a good trading system and great risk management then you should do well. If not, don’t trade.
Under current legislation all profits made from spread bets are tax free**. There is also no stamp duty payable on UK shares* and no commission payable on your trades as the dealing charge is incorporated in the spread. This creates greater transparency in the valuation of your net profit.
** Tax Laws may be subject to change
The Risks of Spread Betting
Although spread betting can be a profitable venture, trading on margin does have risks and drawbacks attached. Because financial spread betting carries a high level of risk, you should only speculate with money you can afford to lose.
Using leverage, it is possible to open large positions for just a fraction of the total outlay. However, if used incorrectly one can easily find themselves receiving a margin call or potentially with a large loss, and in some cases even the closing of their position. Movements in the Underlying can be volatile and unpredictable.
Because of the use of leverage, even a small position taken on a volatile market can result in a large loss. This is why it is imperative that you understand not only the market you decide to trade on but also how much leverage to use based on your account size.
‘Unlike most traditional financial dealing services, spread betting is a leveraged product. This means that your initial deposit payment gives you exposure to a comparatively larger portion of an underlying market than if you bought the instrument directly (via a stockbroker for example).’
What IG mean by this is that you can place small amounts of money on a bet but you are actually leveraging more money than that bet. When you place a bet a spread betting company will ask for you to place a deposit in your account to cover the bet if it moves against you. This deposit can be as small as 10% of the total value of the market. This means that you are only putting up 10% of the risk as a deposit which is why you are leveraging 10% of the money against a potential 100% loss.
For instance if you place a £1 a point bet with a £1000 deposit on a market that is 10,000 points in total and that market absolutely crashed to zero you would owe £10,000. Far more than if you had bought a traditional position in the market at say £2000. With spread betting your deposit of £1,000 does not limit you to that amount of a loss. This is why it is so important to use a STOP ORDER to limit your risk.
Without good risk management, it becomes possible to make significant losses over a short period of time. It is therefore important to understand risk and learn how to manage your bets effectively. I will detail in later posts how to effectively limit your risks.
In certain situations your losses can be unlimited. In the case where a market is closed,or has been suspended, it is impossible to know the outcome of your trade until the market has resumed trading. You must ensure that you understand the potential consequences of any particular Margined Trade and be prepared to accept that degree of risk.
Spread bettors are advised to start trading with small sizes and to trade low volatility markets and only increase once they have a full understanding of market environments and gained experience.
Special attention is also required in understanding the different types of bets one can use.
With most spread betting providers you can trade on 2 different types of market, a Rolling style product or a Future style product. Each contract incurs different costs such as the difference in spread or cost to maintain, and may incur different deposit requirements. Examples of the different type of contracts will be covered in a later chapter. Before spread betting you should ensure you fully understand the risks and seek independent professional advice if necessary.
Another drawback is that the bid-offer spreads are usually a little wider than with traditional trading. Of course, spreads vary from company to company with some offering better spreads on popular financial instruments. Conversely, some financial instruments carry such large spreads that it is impossible to make a profit unless the market makes a significant move in price.
Unlike other forms of trading, spread bets have an expiry date and you will not have the flexibility to wait for the market to turn around so that you do not incur a loss. Once the expiry date is up, your trade will be closed, whether you like it or not. However, you do have the choice to extend the expiry date but this does incur some costs.