For those who can afford to ride the turbulent stock markets, buying shares can be a way to profit from an investment. However, with a lot of red tape and tax implications, share dealing is no longer the most efficient way to make money from an index.
The fragile global economy has meant that gains can be difficult to find in the stock market and any small swings in the right direction can easily be gobbled up by commission, taxes and fees. But there is a way to make money when prices are falling as well as rising, in addition to maximising your profits by avoiding hefty taxes and fees.
Spread betting allows an investor to predict which way an individual share, sector or even an index will move and bet money per point of movement. The bet can either be held open for a number of days, or longer if you prefer, or closed within the same day.
Safety in numbers
Whilst it is possible to pick your favourite stock to follow, one option that spread betting offers investors is the unique ability to profit from the movement of the index as a whole. It is possible to predict how any given index will move, whether it’s the FTSE, the S&P 500 or the Dow Jones you want to follow.
Betting on indices is very different to predicting the movement of an individual company’s stock; there are a variety of sectors to take into account with both upward and downward pressures on the overall movement. However, some analysts argue it is easier to predict trends with such a large collection of shares, making it easier to profit.
Nevertheless, making a profit from a spread bet on an index is far from easy and requires a lot of research as well as an understanding of the factors that will impact on the stock market as a whole. It is also essential to understand the components of the indices you decide to trade on. The differing make-up of indices across the world mean that a uniform approach cannot simply be adopted.
Higher or Lower
Once you think you are ready to roll, you have to make a prediction about which way you think the market will go. If you think the index is certain to drop, you accept the lower price offered by your chosen broker, also known as ‘selling’. If, on the other hand, you are confident the index will rise, you ‘buy’ and take the higher price quoted. These two prices and the difference between them is known as the spread and is how the broker profits. No commission is payable.
Regardless of whether you are selling or buying, you nominate a price per point of movement. This will ultimately determine how much you win or lose. Once you are ready to close your position, you use the opposite price to the one you started with. However, bear in mind, the spread changes constantly depending on market conditions and again, this is how you either win or lose. If the prices have moved sufficiently far enough in the direction you predicted, you make money, but if it goes in the opposite direction, you lose.
The best way to show how this works in practice is with an example:
Let’s say you are a fan of the German DAX 30 and have done your homework on the index. You think the strong German economy is on a downward slide and predict the index will be heading lower. The broker offers a spread of 5810-5812. As you think this is too high, you sell and take the price of 5810 for £10 a point. If, however, you thought the robust German financials would continue to prosper, you would buy and take the price of 5812.
Trading starts and by the afternoon, the DAX 30 has taken a tumble over fears of a double dip recession hitting Europe. The broker is now offering a spread of 5790-5792. You opt to lock in your profits and close your position, this time ‘buying’ and using the higher of the two prices, pocketing £180 (starting price 5810 – end price 5792 x price per point £10 = £180). If you had thought the DAX would be heading higher and had bet £10 per point, you could also have opted to cut your losses and close your position, but you would have had to shell out £220, as you would have used the ‘selling’ price (starting buy price of 5812 – end sell price of 5790 x points per stake £10 = £220).
The above example shows how it is possible to make money even if an index is heading lower. Conversely, if you forecast a downward move and the index shoots upwards, it is possible to lose money even when shares are increasing in value. The important factor in spread betting is not whether the index goes up or down, but whether you predicted its movement correctly.
Getting it right can be tricky and many investors experience heavy losses. However, with the proceeds currently free of Capital Gains Tax as well as stamp duty, spread betting on indices can offer an alternative for those with a good working knowledge of the stock market.