Spread Bets

Index trackers, highly-leveraged CFDs, spread bets, short-selling and algorithmic programmes are drawing increasing attention from traders and investors ready to take advantage of short-term market fluctuations European markets are in the grip of the sovereign debt crisis.

Spread betting is a type of speculative medium where the payout is based on the accuracy of the prediction as opposed to a simple result. Spread trading’s low margin feature means that you essentially have to deposit about 2% to 30% of the total market exposure of your position, depending on the market you choose to trade. When compared to normal shares dealing, the potential for profits/losses as a return of initial capital outlay is likewise amplified. However, here it is worth remembering that losses can exceed the initial outlay.

But how do spread bets work? You multiply the share price by the amount per penny (it’s easier to understand if you understand that penny = point ). A £100 a point bet at 95p that Afren stock will rise is the same exposure as buying £9500 of shares. If you don’t understand this basic fact, you should stay away from spread betting! Especially if you are short…

Compared to traditional buying shares, spread trading permits you to gain exposure to price movements in a stock market that is both rising and falling. Suppose that after you have conducted comprehensive analysis of a particular market, you decide on whether you think it will rise or fall. If you believe that the market is likely to rise, you take a long position (buy). Your profits will then rise in parallel with the increase in the asset price of the market you are betting on, on the basis that you were correct and the market’s price does in fact rise! However, your analysis may turn out to be wrong and should the market fall your losses will likewise increase in line with any fall in that price.

Spread Betting Mechanics:- The mechanics of entering and exiting bets are very straight forward.

Typically, when you want to buy a traditional share, you contact a stock broker who will then issue you with a two way price for the underlying security you wish to buy. The lower of the two prices, which is the one you will get if you are selling the share, is called the bid price. The higher quoted price is what you will have to pay if you are buying shares, and is the offer price.

The difference between the two prices is called the ‘Spread‘.

In principle, this is very parallel with how the spread betters deal with their transactions, where you are offered to way price Offer/Bid.

Why spread betting:-The risk involved in financial spread betting is very high indeed; however I’m a firm believer in using well calculated and precise strategy to beat the financial markets as I believe it generates better returns than a standard stock purchase. The pros are thus numerous and abundant.

Short The Falling Markets

With all the doom and gloom in the financial world, it’s hard to see how you can trade profitably these days. But for traders in the UK, spread betting provides a accessible tool to short sell the falling markets, tax free (tax laws can change remember).

Any spread betting company will provide you the facility to buy or sell any market your interested in. So there would be nothing to stop you from short selling the FTSE or HBOS or any other market you feel is going to drop in value.

This is what makes spread betting such a flexible and powerful tool. You can use it not only to trade on market gains, but to trade on falling markets.

Example: Going Long on Shares

Let’s take the case where you believe that Marks & Spencer shares will rise and you decide to ‘go long’ i.e. taking a long spread bet position, buying at £10 per point at the buy price of 351p.

If your prediction proves correct, and the stock price moves up to 400p you may decide that its time to bail and you decide to close your trade. As a result, you would end up with a tax-free* profit of £490 [(400 – 351) x £10 per point].

On the other hand if the market moved against your position and Marks & Spencer fell to 302p, you would net a £490 loss.

Example: Going Short on Shares

Let’s now suppose that taking the same example above you believed that Marks & Spencer shares were overpriced and due for a correction. You could go short i.e. taking a short position and say sell at at £10 per point, at the sell price of 349p.

In the next few days, the market moves in your favour and the stock price falls; when Marks & Spencer stock reaches 300p, you decide to exit and take your profits, closing your spread trade by buying back at £10 per point at 300p.

By selling Marks & Spencer stock at 349p and buying back at 300p – with a £10 per point stake size – you make a profit of £490. Of course had your prediction been proven wrong and had Marks & Spencer shares were to rise to 398p, you would have net a loss of £490.

Of course, you are not limited to individual shares and can trade many other different markets. Spread betting providers permit you to speculate on entire stock-market indices, like the FTSE 100 (UK 100) or Dow Jones 30 (Wall Street), on commodities such as gold and crude oil, currencies, government bonds and interest rates. And importantly you can deal in all these markets from just one single account!

Margin and Leverage

With a spread betting account it is normal practice to use margin as leverage on your trades. By using margin you only need to deposit a percentage of the actual position value. Each broker has their own margin requirement, in the main it is around 10% of the trade value but can vary across different types of instrument.

There are some brokers who will offer very small margin requirements. Whilst this seems good value as you can trade in larger size without as much on deposit, it also accelerates the risk involved. Trading in large sizes with little funds in a spread betting account is a sure fire way to lose your original deposit. Unless of course this is part of your well researched and pre tested trading strategy.

This does not always mean the brokers who insist on large margin are safer to trade with. Essentially the best broker for you is the one whose margin requirement will allow you to trade safely and in sufficient size to make your strategy work.

Losing Trades And Margin Calls

In the case of a losing trade placed on a spread betting account, some brokers initiate what is termed as a margin call. A margin call is either an e mail or phone call alerting you that your account balance is getting dangerously close to going negative, or your position being liquidated, because your margin on deposit is not sufficient anymore. This give you the option to either deposit more funds to keep the position open, or close out all or part of the trade for a loss. Usually this situation arises when a trader is not trading properly with stops and a correct trade size. The losing trade will eat up any funds in the account until it also starts to eat up the required margin.

New traders should be wise and make themselves familiar with margin and how it works. One of the biggest downfalls of a new trader is to trade in too large a size for the deposit they made. Quickly the balance is eaten away by a market that may only have moved 20 or 30 points against them. When you are starting out, trading in small size not only allows you to cover margin requirement on your spread betting account but also stops you getting stressed and emotional about a trade.

Regarding spread betting, yes it is a fantastic tool if you take a measured and logical approach and cover your ‘holding’. In fact I’d say, financial spread betting is a very flexible speculative tool which allows for all sorts of styles of trading and investing in the financial markets. Spread betting involves using leverage. Spread bets permit a trader or investor to deposit a relatively small amount (referred to as initial margin) to control a comparatively much bigger market exposure. Leverage can work in your favour but it can also work against you if the market moves in the opposite direction of your trade. For this reason leverage can lead to equally large profits or losses. For instance, if you are upbeat regarding the prospects of a company you could either buy 10,000 shares in the company at say £1 a share and pay £10,000 to your brokerage company or buy a spread bet at £10 a point and use £1,000 as initial margin (i.e. open a spread trading account and deposit £1,000). For experienced speculators, leverage provides them with the possibility to take advantage of market opportunities which they would otherwise miss.

Most people who spread bet lose money and that is why they will never be subjected to CGT – the Revenue would LOSE money as the previously non-relievable losses are used to cover other capital gains.

So yes – you could look into spread betting, but its imperative you understand the risks/margins etc. There are no dealing costs per transaction, but rather a small spread (on the buy and sell price) that the firm uses to make money each time you trade.  With modes sums you might want to consider swing trading (2-5 days), rather than day trading.  Otherwise, you risk wiping out your gains by the numerous dealing costs.

Spread bets are more about how much you can risk (% of your overall bank) per trade for a given potential reward, rather than how much you can earn as a minimum. Being consistent (and that doesn’t mean winning every trade) is probably the best next step. Generally speaking risk no more than 2% of your bank on any given trade. If you hit a losing streak, then drop the % even further.

Note: With stocks, you need to know where the market is going – most constituents follow the market and either outperform/underperform it but the trend is set invariably by the market. So whilst I do this, the bulk of my investments are in stocks. I keep an eye on put/call ratios and momentum oscillators to determine when the market is toppy or oversold – you might not get the tops/bottoms but over a slightly longer timeframe (1-6months plus)it really doesn’t matter that much.

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