Why use Spread Bets? Advantages/Disadvantages
I think the tax benefits are probably the largest single benefit over share dealing, the avoidance of stamp duty and capital gains.
Other obvious benefits are the leverage, allowing you with a relatively small amount of money to take a larger position than you would ordinarily be able to do with share trading, and the ability to go long or short, i.e. sell shares you haven’t got in order to take advantage of any downward moves in the market.
What is Financial Spread Betting
Turning a small percentage price move into a big percentage return is called ‘gearing’ or ‘leverage’. Leveraged instruments like spread bets and CFDs allow investors to trade on margin, meaning they can make inflated profits or losses from a relatively small outlay, which can in theory be as small as £1. This is because spread bets are leveraged transactions. You get leverage when you only have to put down a small amount of money to control a much bigger position.
Let’s take an example of a spread bet on BP’s stock price. Say the share price is 450p and you took a spread bet position at £10-a-point, which is equivalent to buying £4500-worth of shares. Whereas buying £4500-worth of actual shares would involve stumping up £4500, a spread betting provider might only ask you to deposit, say, £450 in order to fund the same value position with them.
Let’s assume BP’s share price then rises 12 per cent, increasing the total value of your position from £4500 to £5040. So, you’ve made a profit of £540. However, because you only put down a deposit of £450, your return is £540/£450 = 120%. Not bad going, considering the share price only changed by 12%!
Naturally, leverage cuts both ways. If you get it wrong, your position can get wiped out very quickly. A 10 per cent drop in BP’s share price would eat up your entire £450. To keep your position open, it would be necessary to top up your account with fresh funds. As a result, it is essential to use leverage carefully. This means not taking on positions you can’t easily afford.
Advantages include:
- Play UK, US, Asian or any global market.
- You can make a profit from rising prices – ‘Buy’ low and ‘Sell’ higher to make a profit.
Or
- You can make a profit from falling prices – ‘Sell’ high, then ‘Buy’ back at a lower price to make a profit.
- Use automated orders – ‘Buy’ and ‘Sell’ at the prices you set.
- You don’t need to sit and watch the screen all day.
- Automatically ‘Sell’ or ‘Buy’ to open or close the trade – Take your PROFIT.
- Hedge your bets to cover the risk by placing trades in both directions.
- TAX FREE – No Income TAX or Capital Gains TAX.
Another significant advantage is the ability to short sell. If I look at the markets in their current fashion they tend not to be one dimensional, whereas physical share dealing is inherently one dimensional, you buy and hold. Now some people come to me and say: ‘I’m waiting for the market to go down before I buy’. I’d argue why not short sell it while it’s going down, try and make a little bit of money, and then buy more physical shares if you’d rather on the way up.
With spread betting , it is just as easy to make money from something going down as it is from it going up. You simply reverse the steps you’d do for a buy trade, thereby creating a “short” position.
Perhaps you believe that the FTSE 100 has rallied too far, too fast in your opinion. It presently trades at 5800 but you envisage it falling to 5400 over the next few months. So, you log in to your spread-betting account and “sell” the FTSE 100 – even though you don’t already have an existing “buy” trade open. As a result, you have short-sold the FTSE 100.
Let’s say you are right about the FTSE, which drops to 5400 in a month. To close your short position, you simply place a buy trade, which cancels out your sell trade. You thereby crystallise a profit of 400 points multiplied by the size of your trade. So, if you had placed a spread bet of £10 a point, your profit would have been £4000.
Also technology is important, physical share trading platforms are infantile in their simplicity compared to the platforms being offered by spread betting companies.
Pros:
– Cheapest way of executing short term trades. (the spread is smaller than the commission would be for most private clients working with ‘small’ bankrolls)
– Doesn’t have to be leveraged so you can put a hard limit on potential losses.
– Can work with very tiny to very large bets depending on your bankroll.
– Tax free in the United Kingdom and Ireland.
Cons:
– Can turn out to be expensive if you’re going to be holding a position for over 6 months (i.e. every night your positions will be ‘rolled over’ and the bookie will take his spread again).
– Potentially unlimited if you use leverage (which is why you need to use stop loss orders)
Incidentally, one advantage of spread bets give you access to a wide range of varying instruments to trade. At most spread betting providers, you can trade any of the following:
- Equities – trade individual stocks from over 20 markets – from UK and the US to Turkey and South Africa
- Indices – choose from any of the leading market indices
- Currencies – over 30 diff erent currency pairs are tradeable
- Sectors – trade a basket of Banks to Miners to General Retailers and more
- Options, Interest rates and Bonds
Spread betting may not be right for everyone. It is important that you feel comfortable with the process and with the risks involved before starting to trade. Trading is about 10% knowledge, and 90% application. Learning how to trade is only the start. Learning how to control you own fear and greed, once you start making or losing real money, is the real key. Even more spread betting and trading in general take a certain mentality in order to deal with such unpredictability or volatility and on numerous occasions financial loss.