Many new spread traders have past experience of buying and selling stocks and shares. It is therefore important for a guide such as this to demonstrate the differences between shares and spread betting. For investors who have dealt in shares in the past, it shouldn’t be difficult for them to understand the workings of spread betting.
Shares are traded based on investors’ perceptions of what a company is worth at any particular time. This implies that prices of stocks and shares tend to fluctuate – and some fluctuate much more than others. Traditionally, if you wanted to invest money in a particular company, say because you believe it is likely to continue doing well, or simply because you like the products or services they are offering, you would buy shares in the company. In days gone by, you would have done this by phoning a stockbroker and more recently by using an online trading platform and submitting an order to buy a certain amount of stock. If you happen to buy shares in a company which goes on to perform well, the value of your shares would go up and you would sell them at a profit. So, as we have seen once the stock reached your target profit or you wanted to exit the position because the stock was falling in value you would sell it on to someone else. Well, spread betting isn’t so different – only you do not have to buy the stocks and it is just as simple to sell a market you think is going down as one that you believe will go up. The main difference between spread betting and shares trading is that you do not deal in so many shares or contracts, but in ‘pounds per point’.
“Spread betting offers great granularity, simplicity, low costs (in terms of platform), often a wide range of instruments in one place, and an ability to trade with very low amounts, among other things. Of course, for a trading professional making good money, there is the tax advantage.The main drawback is that you are not trading the real market. Prices can be slightly skewed, you have a conflict of interest with your provider and so on. If trading shares through DMA you could deal directly in the real market but then you have to trade full contracts but that is only a disadvantage if you are under-capitalised. The only real disadvantage to DMA or shares trading is that profits are taxable.”
Spread Trading Vs Traditional Buying of Stocks and Shares
There are many advantages of spread trading over traditional investing in shares which is best illustrated by the following example. -:
|Jim is a Traditional Investor||Mary is a Spread Trader|
|Jim has £10,000 in his trading fund.||Mary also has £10,000 in her trading fund.|
|He looked at GlaxoSmithKline (GSK) at £10 and thinks it will increase in price.||Like Jim Mary thinks the share value of GSK will go up.|
|He decides to buy 1000 shares at a cost of £10,000||Mary doesn’t buy the share in GSK - instead she placed a Spread Trade at £10 per point which required a margin of £1,000.|
|His entire trading fund is taken up completely in the ownership of that share.||(£10 per point x 1000 ask price = £10,000 x 10% margin required by Spread Trading Co = £1,000).
|He OWNS the shares.|
Step forward in time. His hunch was right; the shares moved up to £11 per share (an increase of 10%)
So Jim now has 1000 GSK shares that were valued at £10,000 and are now worth £11,000, giving him one thousand pounds profit.
But Jim tied up his whole trading funds (£10,000) buying the shares.
When he sells the shares he must pay the costs involved in making a trade in this way.
• Broker fees = £25
(assuming a broker fee of £12.50 when buying and selling)
• Stamp Duty = £50
(currently set at 0.5% of value of purchase of shares in UK)
• Tax on profit (CGT) = £280
(CGT @ 28% - assuming threshold of £10,100 is exceeded)
Total costs against trade £355
Total profit on trade £645
(6.45% after costs)
So Jim's total profit was £645 with a 6.45% return.
A good profit; but remember Jim tied up all his trading capital of £10,000 for the lifetime of this investment.
|Mary’s trade in GSK also goes from £10 to £11. This equals 100 points x £10 per point making the same profit of £1,000. Mary’s trade is as follows:
Broker fees = £0
Stamp Duty = £0
Tax on profit (CGT) = £0
Total costs against trade £0
Total profit on trade £1,000
So Mary’s total profit was £1,000.
(100% on initial investment)
Did you notice there is no Stamp Duty or CGT tax? - that’s because the UK Government do not levy Stamp Duty on Spread Trading and do not tax profits of Spread Trading, that gives Mary an extra trade profit of £230 on this one trade.
Also - and this is critical as it explains the amazing power ‘leverage’ gives your capital in clear, simple terms…
Mary did not ‘use up’ her £10,000 trading fund. She only used £1,000 for the GSK trade. That’s the amount the Spread Trading Company required as a margin (deposit) to trade. That leaves £9,000 to make other trades during the lifetime of the trade, multiplying her profit potential.
And every penny Mary profits comes directly to her tax free!
All this means that Mary's total profit on trading exactly the same share as Jim is £1,000 with a return of 100% AND she had the rest of her trading funds free to carry out other trades.
So to recap… Using the same fund amount (£10k) and buying the same share
- Jim made £645 or 6.45% on the capital employed for his trade.
- Mary made £1,000 or 100% profit on the capital employed for her trade (and continued trading with the £9,000 left in her trading account).
The same starting capital; the same stock; but a 92.55% difference in profitability.
Which investor would you rather be?
In fact, one of the main differences between shares trading and spread betting is the ease with which you can do the latter which doesn’t necessarily mean that it is a better option as this depends on what kind of person you are. This is because with spread betting, market positions are leveraged so that profits and losses are magnified. In other words, when you put money in a share, the money you invest is the most you can lose. Conversely, when you spread bet, your stake is multiplied by the movement in the share (this represents your market exposure). So if a stock fell 100pts in a single trading day, and you spread bet at £20 a point, you’d lose £2,000. Likewise, your £20 a point bet would have yielded £2,000 gain if the stock soared 100 points.
Also you need to take into consideration that you will need to keep a very good track of the stock prices all the time whereas a share owner might be a little more relaxed as they at least still own the shares even if they do fall and can hope for a later recovery.
“Financial spread betting does not limit you to trading stocks in individual companies. Of course with spreadbetting you can also trade stocks but you can just as well trade commodities, currency pairs and many other markets. Additionally, with spread betting you don’t own the underlying shares and it is just as easy to sell a market you believe is likely to go down. And you do not presently have to pay tax or stamp duty on your spread betting returns.”
Spread Betting versus Shares Trading
Remember that with spread betting you are not buying the shares directly, you are simply speculating on whether you believe those shares will rise or fall. One factor which favours spreadbets is the absence of the 0.5% stamp duty which is levied on regular share trades, but one cost to bear in mind when holding spreadbets over long periods of time (months) is the impact of financing. An example should help illustrate how straightforward spread betting is. Let’s assume that an investor wants to acquire 10,000 shares in British Airways and is expecting the stock price to rally over the next weeks. For the purpose of this example we will assume that British Airways is trading at 265.75 to sell, 266 to buy. Our investor would need £26,600 to buy these shares (10,000 x 266 purchase price). If using a conventional broker, our investor would have to pay commissions when he wants to buy and sell, let’s assume a relatively low rate of £15 to deal. Moreover, stamp duty would be applicable on shares purchases which at this moment stands at 0.5% so our investor would have to pay £133 in stamp duty alone for buying British Airways shares. So adding commission and stamp duty, trading British Airways would cost the investor £163 (£15 to buy + £133 stamp duty + £15 to sell) in dealing charges and stamp duty alone. And that’s before the share price has even moved one penny. The investor would also have to tie up £26,600 of investment capital in this trade.
Comparing Spread Betting to Shares Trading
Now let’s do the same trade with spread betting. Assuming that the real market price of the share was 265.75/266 the spread bet quote would typically be say, 265.62/266.13 (the spread betting company would wrap a small fixed percentage spread around the cash price – in this case 0.05% on either side). With spread betting you buy or sell so many pounds per point. To put on the equivalent trade size via a spreadbet, our investor would ‘buy’ British Airways rolling daily £100 per point at 266.13p. There is no commission or stamp duty incurred, the only charge is in the spread. Additionally since spread betting is traded on margin the investor doesn’t even need to tie up all £26,600 of his capital in this trade. For British Airways the initial margin requirement may be just 5% so only £1330 would be needed as upfront deposit to open this trade and this would be taken from the investor’s spread betting account against this trade. Once the position is closed out, the margin deposit is no longer needed and any gains or losses will be credited to debited to the investor’s spreadbetting account. However, it is important to note that since financial spread betting is a margin traded product, you could end up losing more than your initial £1330 deposit since you are still exposed to the full £26,600 market exposure.
With regards to UK stocks, a one-point movement in the underlying relates to a one pence change in the share price. Thus, if British Airways rose from 266.13 to 276.13, that equates to a ten point move. Since our investor bought at £100 per point this ten point move translates into £1,000 in profits. Of course if the share price had moved against the investor, for instance, 256.13, this would amount to a ten point loss, which implies that he would have lost £1,000.
The example above deals with a simple directional ‘buy’ trade using financial spread betting to try and profit from an anticipated rise in price of a UK stock. Since there are no commissions or stamp duty due, this form of trading shares can actually work out cheaper (a small financing charge may be incurred each day the contract is kept open). In addition, any profits from spread betting are tax-free. For investors using a standard dealing account, any gains over and above the annual exemption of £10,100 would be subject to Capital Gains Tax (CGT).
Also, you can get a guaranteed stop on shares but you can (at a price) on spreadbets. One problem with spreadbets is that with smaller trading capital it can bugger up disciplined money management. Suppose you only had £10,000 capital and wanted to buy 10 stocks of equal value. That would be very difficult to do with spreadbets as you are restricted with multiples of £1 per point x 100 margin. So to use PFC as an example using last night’s closing price of 1542p the minimum spreadbet you could place would be 1543 x 100 x £1 per point. That means that your holding an equivalent £1543 worth of shares, which is 50% more than you really want. Take another example WG – closing price 662p. The minimum spreadbet holding at £1 per point would be 662x100x1 = equivalent of £662 worth of shares, which is well below your £1000 per stock requirement. The next option above £1 per point is £2pp. But that gives you 662x100x2 = equivalent of £1324 of shares. So that’s what I mean when I say spreadbets can bugger your discipline and your strategy. If you buy actual shares you can buy exactly £1000 of PFC or exactly £1000 of WG. If I were fixed to trading £1000 lots I’d limit spreadbets to stocks with a share price below 500p so that you still have a degree of flexibility to get close to the £1000 equivalent holding target. Any size above 500p and I’d probably buy shares.
“Spread betting is most suitable for short to medium term trading and for smaller position sizes held over short periods spread betting has the edge over traditional shares dealing. There is a financial cost for holding a long (bought) position and an opportunity cost if the short (sold) positions you hold are not moving.Please also note that although the power of leverage and the abilities to trade on margin as well as deal in diverse markets makes spread betting a popular way to trade, spread betting is not suitable for everyone and some considerations are required before moving forward. In particular, spread betting may not suit your needs if you intend to buy and hold positions for long periods of time (6 months plus+) and secondary consider whether spread betting suits your risk appetite; spread betting being a leveraged product means that it can be extremely rewarding, however the losses can likewise be magnified.”
Spread Betting vs Shares Trading
Lastly, one has to keep in mind that financial spread betting and share trading are not mutually exclusive investing methods. In fact a number of stock market traders utilise financial spread betting as part of their wider investment portfolio. For instance, they might hold a number of long term physical shares but also mix this with some sort of short-term market speculation and this is where spreadbetting can be so powerful.