Gambling or Investing
In this guide I aim to challenge some of the commonly held beliefs about spread betting: that it is all about day trading exotic currencies and commodities, that it requires a lot of money to get started, or that it’s risky and dangerous. All of those beliefs about spread betting can be true, but they don’t have to be.
In this introduction I will start gently by telling you (or reminding you) what financial spread betting is, and how it is similar to – yet different from – traditional share dealing. If you’re a seasoned spread bettor already, don’t lose heart as there will be plenty of advanced material in later chapters. This introduction (for new spread bettors) or revision exercise (for existing spread bettors) will ensure that we’re all starting with the same understanding of what financial spread betting is.
Spread betting is all about trying to profit from short-to-medium term swings in all kinds of financial markets. Whether you’ve got a view on something like the direction for the FTSE 100 or the GBP versus the USD, financial spread betting permits you to try to gain from that view.
Spread betting (or spread trading as its sometimes referred to) provides an opportunity to profit from the rise or fall in the prices of financial instruments. Instead of taking ownership of the underlying instruments, spread traders simply enter into a contract based on the direction of its price. As such spread trading is exempt from brokers’ commissions, stamp duty, and capital gains tax, making it a cost efficient transparent and instant means of trading the financial markets.
Clients can trade a wide variety of financial instruments including equities, indices, commodities, currencies, precious metals, interest rates, and bonds.
Before we begin, let me get something off my chest…
Gambling or Investing
Much of the traditional investment literature will lead you to believe that spread betting is the more dangerous poor relation of the more noble art of “investing”. When you are spread betting, you are gambling, whereas when you are “investing” you are loyally backing British (or other) business based on your considered opinions about their prospects.
Well, here’s my view on it!
Spread betting is just another trading medium like a stock broker share dealing account, stocks-and-shares Individual Savings Account (ISA) or Self-Invested Personal Pension (SIPP). You can trade or “invest in” Barclays Bank shares (for example) using any of those platforms, and in every case you are hoping that you can sell the shares next week, next month, or next year, for more than what you paid for them. There are some subtle differences, which will be explained shortly, but in all cases you are taking the same speculative “gamble”.
For the record, I am actually more “investment” than “day trader” oriented, and yet I prefer spread betting to traditional share dealing.
Many investors and traders utilize financial spread betting as part of their investment strategy. Most have already monies in savings accounts or ISAs as well as a share portfolio and spreadbetting is simply another way to maximize returns.
What is Financial Spread Betting?
A buy and hold investor saves for the long haul. On the other hand a trader is constantly on the watch out to profit from short-term asset price movements. For a trader ‘timing’ is key and he has to constantly monitor positions, news flow and charts looking for entry and exit points. For private individuals, the easiest way to trade is to open a spread betting or CFD trading account.
In layman’s terms financial spread betting is a tax-free* way of making money when the prices of equities (i.e. stocks or shares), stock indices (like the FTSE 100), commodities (like oil and gold) and currencies (like the US dollar) go up or down.
* UK tax laws could change in the future.
You’re not buying or selling “shares”, you are simply placing a bet with a broker that the price of the stock (or other financial instrument) that you chose will rise or fall. With financial spread betting, you are betting a predetermined amount of money per ‘point’ on a given asset (normally £1 minimum, albeit some brokers offer smaller stakes). A ‘point’ can be anything from a point on the Dax 30 index, to a small price fluctuation in the value of the dollar.
The word “spread” refers to the difference between the buying (ask or offer) and selling (bid) prices of the instrument you are betting on. It’s like when you buy or sell a car and the dealer offers you a lower price to buy your car than the price he will charge someone else to buy it from him. That’s how he makes his money, and that’s how the spread betting companies make their money too. You might be able to buy (bet long) Vodafone shares at a price of 171p-per-share, but the spread betting company will only give you 170p-per-share (for example) when you want to sell them back. If those shares rise by 5p-per-share between you buying and selling them, to 175 / 176 then you have made a 4p-per-share profit and the spread betting company has taken the other 1p-per-share. In this case everyone is a winner, and the spread betting company almost always is a winner thanks to that 1p-per-share price differential or “spread”.
Let’s take another example. Say you believe the FTSE 100 index is looking weak. Your broker quotes you a price of 6,500 – 6501. This is referred to as the spread. Suppose you ‘sell’ the spread at 6,500 at £5 a point. Let’s say the market then went down to 6480, you could close the position and make about £100 [20 x 5]. And if it went up sharply to 6540, you’d be down about £200 [20 x 5]. To limit losses, you could place a stop loss order which will automatically close your position at a certain point.
Key advantages of spread betting include the ability to go short and profit from down movements, the ability to trade a very wide range of diverse markets, the leverage provided and the potential tax benefits. However, keep in mind that most traders end up losing money in the long run and it can become addictive. So before starting out, make sure you have a trading plan – and stick to the plan!
The words spread betting implies that there is a gamble and element of luck in trading, but in my experience trading the markets profitably cannot be further away from the action of gambling. Investing in your education so as to understand how fundamental news moves the markets and how technical patterns and levels lead to self-fulfilling market movements will not only give you the tools and knowledge to trade but also the confidence to be profitable. Trading with confidence and with pre-defined goals and stops is how to profit from trading; if you fail to plan in trading, you are inevitably planning to fail.