Now you understand what spread betting is and how it works (roughly), the next question is why would you bother to use spread betting instead of trading in the normal way? Well, there are a number of reasons, and between them they amount to a pretty powerful argument.
First, it is very easy to understand. Unlike options, futures, and contracts for difference, spread betting is simple and works the same way no matter what the underlying financial security is – but like options, futures, and contracts for difference, spread betting still leverages the effectiveness of your money, allowing you to start with a small amount of capital, perhaps less than £100, and still be able to make good profits.
Secondly, it allows you to profit whether the market is going up or down, and you can pick the market that you want to play from a vast range of financial securities, including foreign indexes and even stocks. It is totally up to you what financial sector you are interested in or think you know something about, and you are almost bound to find a spread betting provider who will allow you to bet on it. In fact, you only need one account to deal in a whole range of financial products.
Thirdly, it is classified as gambling. This is great because it means that your gains are not taxable in the UK and most other countries. If you deal in shares, then you will be taxed – it might be capital gains tax when you sell, or if they regard share trading as your main means of income, you could be taxed at your income tax rate. Either way, you lose some of your profits. And if you hold shares when they pay dividends, the dividend payment will be taxed at your current income tax rate. There is none of that with spread betting.
Of course, there are other savings. You don’t pay a commission, the dealer’s fees are included in the bid-offer spread. Unlike shares, you don’t have to pay stamp duty which is currently half a percent. You simply don’t own the shares anyway, so there is no way you can be charged stamp duty. All you’re doing is profiting from the change in share price.
Want another advantage? If you’re interested in foreign shares and indexes, spread betting makes it much easier to profit from these. There is no currency risk, you don’t have to worry if the value of the dollar or the yen goes up or down while you are in a foreign trade. You simply bet an amount in pounds sterling on the index or the share price, and then watch for it to move in your direction. There is nothing illegal or awkward about this, you can bet in pounds per point no matter what currency the underlying index is quoted in.
Note that you are not trading on a stock market, and your dealer is not acting as a broker for you. All bets you place are directly with your spread betting company, so there is no delay in placing your order. This also means that there are spread betting companies that will take your orders 24 hours a day, rather than being restricted to market hours. Because of competition, you will find that most companies will quote you similar prices, but it is worth looking for “the edge” in the spread when shopping for an online dealer.
While there are a lot of advantages to spread betting, you also need to know the downside. Obviously, the major downside is that you can lose more than your initial deposit or capital. But that applies to any of the leveraged financial products you can trade in, and that is the price for being able to generate profits rapidly using a geared investment. In effect, margin is a form of borrowed money that empowers you to leverage up a trading position. But beware that this cuts both ways and the way spread trading works means that it will magnify both losses and gains, particularly when the multiplying effect of trading euros (or pounds) per point is taken into account.
Suppose, you have for instance £400 in your spread trading account and you decide to buy the FTSE 100 at 5,600 at £5 a point, with a stop loss order at 5,400. Here you are risking 200 x £5, or £1,000 – a sum far greater than your initial stake, even with the stop loss. Later in this guide we’ll cover the ways in which you can guard against massive losses, and if you’re trading properly you should not take or stay in any trade that is going to cripple your finances.
All spread bets have an expiry date, and that is when you will incur any losses on your trade. If you just buy shares, you don’t have to take your loss until you sell them. Sure, this may delay the inevitable, but you need to know it.
Also, if you spread bet on shares there is no way you will get the dividend, unlike when you own the shares. Actually, there are ways and times when a dividend is priced into the share price, and if you follow share prices around dividend time, you know what I mean. It can sometimes be a good trading strategy, and we’ll talk about it later.
Because the dealer’s money is in the spread, you do have to make up spread before you start making a profit. While I list this as a disadvantage, I actually like it because it’s much easier than working out commissions and how they affected your trade. It will cost you money however it is charged, and the spread is easily understandable.
If you do happen to make losses, then these can’t be offset against any capital gains you make on conventional trades or investments. I guess this is only fair, as you don’t pay capital gains tax on your gains.
If you’re looking for long-term investments, then spread betting isn’t a good way. As mentioned above, spread bets are in place for a certain time and have to be “rolled over” if you want to extend the time. This will cost you a minimal amount each time. If you buy shares instead, then you can hold them indefinitely for no charge.