Financial spread betting originates back to 1974 when Stuart Wheeler established IG Index to allow investors to trade the price of gold without incurring hefty charges through the exchange controls applied if the actual metal itself was bought. Initially, financial spread betting was popular mainly amongst institutional investors, city traders and high-rollers, but the trading product has now started to becoming more mainstream with private traders.
In fact, if you were to make a list of financial products that have attracted the interest of the wider investing community over recent years then spread betting would definitely be near the top. It has been around for decades but developments in technology and financial markets has meant that spread betting as a trading medium has soared in popularity in the the last few years.
But what is spread betting and why is it so popular?
Spread betting can appear daunting when you are just starting out but once you’ve gained a bit of experience it’s a brilliant way to trade. This guide is designed to explain all the ins and out of financial spreadbetting.
What Spread Betting is, and What it is Not
There is some confusion about what spread betting is, and what is not. Spread betting originally came about in the sports world when gamblers were looking for a way to bet on an outcome which was not just winning or losing. With spread betting, you can gamble on how many points a team will win by, and your winnings depend on how right you are. The spread is a range of points, and a common form of spread bet is whether the favourite will win by more or less than the point spread offered by the bookmaker.
But this guide is not about sporting events, or even about gambling in the usual sense of the word. The ‘spread betting’ activity that you will learn about here is more appropriately described as financial spread betting, and winning or losing depends on how well you can predict the movements of the financial markets or other securities. You will see later on in the guide how you can study the markets and make a profit. In this way, financial spread betting is very similar to stock trading, although it is available on a much wider range of financial instruments and it has some significant benefits with regard to taxation. The obligatory warning is that it is quite possible to lose as well as win with spread bets, and you can lose more than your original stake, or deposit.
Spread betting provides you the opportunity to attempt to take advantage of movements in financial markets, so if you think that the FTSE will continue rising as more evidence of green shoots sprout up, then you can by the index in a spread bet. Or you can place a buy bet on a particular stock if you believe if will outperform the index.
Advantages of Using Spread Betting to Trade
Financial spread betting has several advantages compared with other forms of financial trading. Firstly, it is a geared or leveraged way of profiting from the markets, and this simply means that the value of your money is multiplied. Rather than having to buy stocks and making a few per cent profit when the price rises, you can spread bet on the stock with much less capital than you would need to buy it, and make the same good profit when the price goes up. This gearing is incidentally also the reason that you can lose more than your initial investment if you bet the wrong way, and the purpose of this guide is to give you pointers to winning more than you lose.
Secondly, because you never buy the stock you are not charged stamp duty, and you also do not pay trading commissions. The profit for the dealer or broker comes from the spread between the buying and selling prices that you will be quoted when you go to bet. Additionally, because betting is a form of gambling, any winnings are not subject to capital gains tax in the UK and some other countries. It’s been said that if you have no other form of income then the spread betting winnings could be regarded as your income and therefore be subject to income tax in the UK, but this has not proved to be a problem to most spread betters.
For these obvious reasons, financial spread betting has become very popular in recent years, and together with contracts for difference (CFDs), another very similar way of leveraged trading, has become the preferable way of profiting from the markets for many traders.
Financial spread betting is one of many forms of trading the global financial markets – and it is regulated by the United Kingdom’s Financial Services Authority (FSA).
Spread Betting Example
Just to make clear what a spread bet looks like, here is an example of a spread bet placed on the FTSE 100, the major stock market index for the London Stock Exchange.
You ask your spread betting broker for a quote on the FTSE 100, and he will give you two figures, say 5701 and 5703. In this case he is quoting you a spread or difference of two points. The spread will vary depending on what underlying item is being traded on, and can also vary between brokers. If you want to bet that the FTSE 100 index would increase, you could “buy” at 5703; if you thought the index would fall, you could choose to “sell” at 5701. As mentioned above, you’re not actually buying or selling any shares, but these are the terms used.
For the sake of this example, assume you decide to buy at 5703. Rather than buying or selling physical shares in a company, the way it works with spread betting is that you bet a certain stake in either pounds sterling, dollars, euros per point (depending on what currency your account is denominated in) to determine how much you win or lose when you open a trade.
You buy at 5703. So as we said your spread bet is a wager of a certain amount per point, usually with a minimum of £1 per point. Say you decide to bet £10 per point. A little later the same day, your broker is quoting the FTSE 100 at 5765 and 5767, and you decide to take your profit. To close out the bet you now need to “sell” it, which you do at the lower quoted price of 5765. You bought at 5703 and sold at 5765 for a total point gain of 62 (5765-5703). At £10 per point you have profited £620. Now you can also see where the broker’s profit comes from – the actual increase in the buying and selling prices was 64 points, but as you have to buy at one and sell at the other, the broker profits by the amount of the spread. This is simple to understand, and there are no hidden fees.
Now you may have heard some negativity and rumours about financial spread betting, so let’s just clear up the misconceptions before going into more details. The first myth is that nobody wins at financial spread betting. That is obviously not true, otherwise nobody would do it and least of all the major institutions. The market for it is increasing at a rapid rate, as people come to understand the advantages over normal trading. However, statistics show that about 90% of people who dabble at spread betting lose money and give up in the first few months.
Why is this? Well, it’s probably because many people go into it unprepared, without learning the details of what they’re doing, and treat it as a bit of a gamble. Similar failure figures apply to most forms of trading. However, some people who are prepared to learn and put some work into it continue to make a substantial income. Hopefully, you are prepared to work at it and that is the reason that you are reading this guide to spread betting. The fact is that there are two sides to every spread bet, one thinking that the price will go up and the other sure that the price will go down. That means all spread bets will have a winner and a loser, or in rough terms 50% of spread betters will lose. It’s slightly more than that, because the broker takes the spread. The fact that far more than 50% lose means that those who win must be winning much more money than the amount lost by the failures, and as long as you plan and prepare to be on the winning side, this is good news.
Another myth is that spread betting is just like futures and options, implying that it is complex and likely to cost you large sums. This is not true at all, futures and options require a great deal of money to trade in comparison, and are much more complex to analyse. What they do have in common is that they are all highly geared which gives you the power to make more money, and that you can make money when the price is going up or down.
A third myth is that you need to be wealthy in order to spread bet. This isn’t true, you can open an account with as little as £100. While spread betting with this amount is not going to make you wealthy, it is enough to help you learn to trade. In a later chapter, I will talk about the psychology of trading and you will see that you should not trade with more than you can comfortably afford to lose, to avoid the irrationality of emotion. Being able to start with a small amount helps you to establish this mental attitude.
Finally, you may hear people saying “If it’s that easy, why isn’t everyone doing it?” The fact is that many people, an increasing number, are doing it even though they may not be shouting about it. It requires work, but that work is straightforward and easily understood, and this guide will explain how you do that.
By the way, it may have occurred to you that if in the example given above you had sold instead of bought, you would have lost £660, including the spread. Yes, you can and will lose on some spread bets. But you would really need to be asleep if you allowed this size of loss to happen. As you will see later, one of the secrets of trading is to “cut your losses” before they become large, and in practice you would have closed out this spread bet way before the loss got that high. We will see in the section on types of order that you can arrange for this to happen automatically, even if you’re not watching the market.
In summary, financial spread betting is a very efficient, in the sense of making the most of your money, way of trading on the financial markets, and is easy to understand. To make a consistent profit, you need to study the things that any trader needs to know, such as how to use price charts and how to analyse the price movements, and much of the rest of this guide is given over to discussing how to do this.