Spread betting is the simplest way of trading in financial markets, making it easy for everyone to trade. Still, some people use it for gambling, losing their money quite rapidly.
The biggest difference between financial spread betting and conventional trading lies on the amount of leverage involved. When you buy shares, you usually need funds to cover the purchase price times the number of shares purchased. Sometimes, a broker may offer trading on margin and allow you to magnify your funds 2x, or maybe 3x. In spread betting though, it’s not unusual to see leverage amounts of 10x, 100x or maybe more. With minimum deposits now being really low, many traders deposit just £100 or £200 and push leverage to the limits, which is a recipe for disaster. Most spread betting traders lose their money rapidly, as they attempt to win the lottery with just a few pennies.
But, for those who know what they’re doing and keep risk well managed, spread betting gives a lot of flexibility, many times making possible certain operations that were just difficult or too costly to implement using a conventional account.
Without intending to be exhaustive, let me discuss about some key advantages of spread betting over conventional trading:
- Global offer – Spread betting providers usually offer access to all types of markets from a single account. The offer varies from broker to broker, but expect something between 1,500 and 5,000 different assets. Some may offer even more and others are willing to add new securities upon request. These assets spread across stock indexes, ETFs, currencies, stocks, bonds, interest rates, options, commodities, and some peculiar offerings at times. For the purpose of portfolio management this has the advantage of allowing you to manage risk more effectively than with a conventional broker. But, while the offer is global, you don’t have access to every possible asset. If you’re looking for specific ETFs or small caps, you should investigate first if the broker offers what you’re looking for.
- Leverage – A few years ago, all spread betting brokers used to offer extreme leverage. But as legislation changed, they adapted to the new reality. You can still trade on margin, even though the limits are now tighter. In my view, that’s not bad news, as too much leverage would only lead you to lose your money… and fast. Most brokers offer more leverage than you really need. Still, when used properly, leverage should be an asset and an advantage over conventional trading.
- Low Commissions – While ignored by many investors and traders, commissions are their worst enemy. Good investors always try to reduce position rotation to a minimum to avoid commissions. In many cases a roundtrip is costly and makes a big difference when you want to turn your gross profit into net profit. In spread betting, commission is usually added to the bid-ask spread. This has the advantage of not depending on trade size, such that buying one big lot or 10 small ones is similar in terms of commissions. However,using leverage means borrowing funds, which is costly. Spread betting providers charge you an overnight financing cost. While the interest rate charged comes in the form of a small spread over base rates, you should take this cost into account when keeping positions open for long.
- Easy to Understand – Instead of buying a share, in spread betting you bet on a price rise. Let’s say your stake is £10 per point move on a share initially trading at 175. If the price rises to 200, your gross profit accumulates to £250 (25 points times £10). If it declines to 150, your gross loss accumulates to £250. You don’t really own the stock because this is a derivative product, but the cash flows involved may be similar.
- Easy to Sell Short – While we refer to short positions as the opposite of long positions, technical details and trading issues make them less than symmetric. It is a lot more difficult to sell an asset short than to buy it. To complete a short sale, you need to borrow the asset from someone who is long on that asset, which may or may not be possible. Some other restrictions exist. Spread betting highly simplifies the process, as you can always decide the direction of your trade, either buy or sell, with the same easiness.
- No Stamp Duty – When you buy shares from UK companies you usually pay stamp duty. If you use spread betting, there’s no stamp duty.
- No Capital Gains Tax – When you sell shares, you usually have to pay capital gains tax on your winnings. But, gains from spread betting are exempt from this tax.
- Trade In Your Currency – Another great advantage of spread betting is the elimination of foreign exchange risk. You may trade the FTSE 100 in GBP, EUR or USD. The same is true for shares and other instruments. Assets are quoted in units, with units being whatever currency you choose, provided it is available at the spread betting broker.
- Continuous Trading 24h/day – You can trade all the major equity indices, foreign exchange, commodities and some other assets in an almost continuous base, at any time. Apart from a few minutes every day and Sundays, most markets trade continuously.
Spread betting is one of the most effective ways to trade the markets. It allows you to have access to almost every asset from a single account and to trade easily. However, many traders are lured by leverage, turning trading into gambling. The differences between trading/investment and gambling rarely depend on the object of the action but much more on the attitude of the person towards risk. Depositing £100 into a spread betting account, in the hope to earn a few thousand is like buying a lottery ticket. There’s not much strategy involved and even less risk management.