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The Long and Short of Financial Spread Betting

Posted By Robert On Tuesday, December 10th, 2013 With 0 Comments

Much of the coverage in this guide will, for simplicity, be presented on the basis that you will be trading “long”: buying a spread bet in the expectation of a price rise and then selling the bet (to close it) at a profit when the price has risen.

Unlike traditional share dealing, it is perfectly possible to do the opposite by going “short”: selling a spread bet in the expectation of a price fall and then buying back the bet (to close it) at a profit when the price has fallen. In the following figure I have re-cast the original spread betting example that I presented in this chapter as it might have played out for a “short” trader. On the first bet, this trader wins £28 by selling short at £2-per-point before enjoying a 14-point price fall. On the second bet he loses £23 by selling short at £1-per-point and suffering a 23-point price rise (including the effect of the bid-ask spread).

Long and Short

Once again this is not an example of good trading, but it shows how a spread bettor can make money by selling short prior to a price fall, or lose money by selling short prior to a price rise. The long and short of it is that spread betting is entirely agnostic regarding which way you choose to bet.

As legendary trader Jesse Livermore once said:

“There is only one side of the market and it is not the bull side or the bear side, but the right side.”

The Long and Short of Rolling Charges and Dividends

Well, it’s not quite true to say that spread betting is entirely agnostic regarding which way you choose to bet. There are a couple of subtleties regarding rolling charges and dividend receipts:

  • Theoretically you should receive rather than pay overnight financing (rolling) charges on any short spread bets you hold. If base interest rates were at 5% you might expect to receive 5% – 2.5% (the spread betting company’s “haircut”) = 2.5% on your short spread bets. But with base interest rates at 0.5% you would find yourself still “paying” for the privilege of holding a short bet, to the tune of 0.5% – 2.5% = -2%. The minus sign in this case indicates that you are paying the net interest, albeit at a lower rate than the 0.5% + 2.5% = 3% that you might be paying to hold your long bets.
  • Whereas on a long spread bet you stand to receive dividend credits when the underlying companies or indices declare their dividends, on short spread bets you are obliged to pay those dividends for the benefit of the traders taking the opposite (long) side of your short bets. Once again, the spread betting companies take a cut by crediting long traders with 80% of the dividend while debiting short traders 100% of the dividend amount.

Making Money, not Storing Wealth

Many people think that you need a lot of money in order to start spread betting, but I don’t think that’s true. And it may even be detrimental to have a lot of money burning a hole in your pocket during the spread betting learning curve, because: the more money you think you can afford to lose, the more money you will lose! I used to think that in order to make a lot of money in the markets, you needed to start with a lot of money. I now know this not to be true, at least as far as spread betting goes.

One of my friends once asked me “How much money do I need to have available to invest in order to start betting?”

Apart from the fact that the word “invest” in his question was probably the wrong word to use, the simple answer was…”Very little!”

Making Money

Thanks to the leveraged nature of spread betting, in a particular six-month period in 2009 I was able to achieve an embarrassingly-high 3000% leveraged return on my spread bet investments. This £30,000 payout for every £1000 “invested” is completely at odds with the conventional wisdom that you should aim to make the same £29,000 “profit” by securing (for example) a 5.8% return on your £500,000 life savings.

Not Storing Wealth

I would never deposit a £500,000 “life savings” pot into a spread betting account for safe keeping, because I know that the beneficial leverage can also become malevolent leverage.

I have occasionally seen draw-downs of up to 50% of the funds I have deposited into spread betting accounts, which makes it all the more fortunate that I only ever re-deposit a small fraction of my previous “winnings”. You really don’t want to lose £250,000 of your £500,000 life savings.

To my mind, it’s best to treat financial spread betting as a way of potentially making (or losing I’m afraid) a lot of money from very little, with a view to then finding a safe haven (if there is such a thing) as a store of your accumulated wealth.

Should YOU Be Spread Betting?

Obviously I can’t answer this question for you, because I don’t your circumstances and I’m not authorised to give advice. My generic answer is that you should consider spread betting if…

  • You want to learn the trading and investment ropes using a lot less money than you would need to “invest” with a conventional stockbroker.
  • You want to try and trade small amounts of money up to large amounts of money, and you’re not looking for spread betting to be a safe haven for your accumulated wealth.
  • You don’t want your trading profits to be degraded by paying tax (currently, in the UK) or you don’t like filling in tax returns unnecessarily.
  • You are willing to invest your time in learning how to manage your trading risk.
  • You do not have the kind of devil-may-care attitude that will lead you to “bet the farm” on one throw of the metaphorical dice.

Can YOU Make Money Spread Betting?

Well, that’s the idea, isn’t it? But you’d be surprised at how many people do it despite not making any money at all.

Whether they care to admit it or not, for many people spread betting is a form of entertainment that ranks alongside horse racing and poker. But whereas casino games are games of pure chance, horse racing and poker (and financial spread betting) imply at least some degree of skill such that there are professionals who make money out of it… or at least try to. Whoever heard of a professional bingo player?

Some people play the markets via spread betting and other forms of speculation (including ‘investing’) because they enjoy the intellectual challenge of pitting their wits against the markets; for much the same reason that people play intellectual games like chess. Spread betting can be harmless enough as a challenging ‘hobby’ if you confine your play to small stakes, and it’s a hobby that – if you’re lucky – could pay off in a way that spending your time on the golf course won’t.

When all is said and done, most of us go into spread betting with the intention of making money. And some of us do. There are different ways of measuring whether you are making money by spread betting, and it depends on your trading timescale, but the acid test is this:

Have you managed to withdraw more from your spread betting account than you ever deposited? Then you’ve made money, and your spread betting has henceforth become a self-sufficient money machine.

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