Spread betting is tempting. There’s no doubt that many people have considered doing it, and spread betting has grown by leaps and bounds in the past few years. Things that make it more attractive than general financial trading include the preferential tax treatment, the leveraging of your money to potentially give large profits, and the easy to understand way that you can place and profit from bets.
But if you read much about spread betting, you will see warning notices that advise you that you can lose far more than your account, and that can make your spread betting provider chase you for more funds than you wanted to spend. This is called a margin call, and is something you have to respond to. If you have lost money, then the broker can come after you legally for restitution.
So wow! Spread betting can hit hard! Make no mistake, trading spread bets is a high-risk strategy… Those who get hit the hardest are probably the most casual about placing spread bets, because they regard it as gambling and put on bets as they would on a horse race. That doesn’t usually work very well with financial spread betting. After all, you can be quite cavalier about losses on a horse race, as all you can lose is what you gambled, yet your winnings can be several times your stake. Financial spread betting doesn’t work like that.
Spread betting is different because it is much more like trading than gambling. These same people who would gamble money at a betting shop and treat spread betting the same way might never dream of financial trading on derivatives such as futures and options, but that is the mind-set that you need when spread betting. Financial spread betting is, by definition, a derivative, as it doesn’t entail ownership of any financial securities, but “derives” its value from the underlying security.
Whenever you place a spread bet, at that instant you have lost money. If you close your bet straightaway, you will lose the amount of the spread. But that is the price of spread betting, and all you need is for the security or index to move a few points in your direction to breakeven. In return for this small price, you don’t need the complication of commissions, stamp duty, or any other charges.
But that is not where spread betting hits you hard. If you ignore the movements of the market, if you leave your bet in place even when the price is moving against you, that is when you will find that your finances are hit hard. You cannot treat a financial spread bet like a sporting bet, ignoring it and waiting for the result to see if you have won. You have to stay on top of the market, and cut your losses where you need to on a losing bet.
Unlike with traditional shares trading, spread betting losses can be rapid and unlimited, making it a higher-risk business. This is especially true if the market were to sharply move against you position. For instance, let’s assume you put down a 10% initial margin (£500) to take on shares worth £5,000. Unfortunately, the company issues a profit warning the next day and the shares open 20% lower. You decide to cut you loss at £4,000, crystallising a loss of £1000 in the process – your original £500 stake plus an extra £500 which you will have to fork from your savings.
In an effort to reduce the risks and attract more mainstream retail investors, spread betting providers have introduced guaranteed stop-loss systems that automatically close client trades if losses reach a pre-determined level. Investors pay a premium for guaranteed stop orders in the form of a wider spread.
Spread betting is tempting, and if you approach it with a business-like attitude, researching the market and realizing that not all bets will win so you must quickly eliminate your losses, then you will profit and not be hit hard financially.
“So according to industry veterans spread trading depends much on the respect between you and the market. Fair enough, I agree. And I’ve heard many horror stories about how people have lost big on leveraged investments. So Mr Market, you have my fullest respect – please don’t take all my hard earned savings and leave me on the streets.”