What is Financial Spread Trading?
Financial spread betting is a flexible way to trade the financial markets without holding the physical ownership of investments. It allows you to speculate as to the direction of a number of markets and is a margined (leveraged) investment vehicle.
Financial Spread Betting is not new and has been in the UK for almost 30 years but has grown in popularity in recent years and the competition between firms has intensified in order to attract new customers by offering tighter spreads and improved customer service.
Placing a spread bet gives you, as the consumer, an instant access to the price of the financial markets, permits you to take long or short positions without the stockbroker’s interference and allows you to trade all the different financial markets – indices, commodities and currencies, individual shares and bonds – from a single account. It does not see you actually buying shares or commodities but instead placing a bet as to which way you believe the market or share price will move.
Spread betting was once only associated with big financiers in the city. However, the ever evolving market has changed the perception and association of this fantastic financial tool. The fact that is now the number “one” choice of financial derivative for private investors is not surprising due to the range of benefit it offers.
Spread Trading offers the private investor a fully tax-free alternative to trading the worlds financial markets. It may be difficult to tax as a lot of people tend to lose, I would guess because they don’t do the research or properly learn the implications. However, financial spread trading isn’t new. It’s been around for more than 30 years, but it’s only been in the last few years that it’s really grabbed the attention of private investors.
In recent years, the financial markets have grabbed the headlines. Since 2008, we’ve experienced the credit crunch and a banking crisis, an ensuing global recession and what feels like the never-ending sovereign eurozone debt crisis. It is not a secret that traders thrive on market volatility and in this day and age it is quite easy for anyone to keep track of developments in the stock markets.
In this guide we discuss the place of spread bets within a speculative investor’s portfolio, as opposed to a day trading account.
- Why trade Spread Bets?
- How do I trade Spread Bets?
- Nuts and Bolts of trading Spread Bets
- Managing your Trade
- Trading Strategy
How do you define Financial Spread betting? Spread betting is an art of outperforming the market through the use of well calculated and precise strategy.
A spread trade allows an investor to speculate on whether the price quoted for a given financial instrument is likely to go up in value (strenghten) or go down in value (weaken). The instrument could be an equity such as shares, or a bond, commodities or foreign currency pairing (example dollar-euro). Or, it could be an index which represents the top shares in the United Kingdom, USA or other country. Financial spread betting different from physical share dealing because you don’t actually own the underlying instrument. Investors have to place a deposit into their spread betting account and then they will use this ‘leverage’ (sometimes called margin) to speculate solely on price movements.
NOW THERE’S A WAY TO MAKE THE MOST OF MARKETS THAT FALL AS WELL AS RISE
The ‘speculating’ on price movements is key as it allows them to profit both when a market is rising and also when it is falling. Spread Betting, however carries a high degree of risk to the investor. Due to fluctuations in valuation, the investor may not get back the amount of the original investment, and in certain circumstances be liable to pay a far greater sum.
There’s also no commission charges, the transaction costs can be lower and you don’t pay tax on any profits you make.
* Profits made by a UK residents from spread trading are exempt from UK Capital Gains Tax, stamp duty and income tax, however tax treatment depends on your individual circumstances and may change in the future.
Is Short Term Stock Trading Redundant?
You know, it really used to be that short term trading was the best way to profit from the movements of the stock market. But in the last decade, a newcomer has come up to challenge it and surpass it in many fields.
It seems that spreadbets have no limitations when applying them to markets. Unlike the Forex market, you are not limited to dealing just in the currency fluctuations. Unlike the stock market, you are not limited to dealing just in company performance. Once you have a spread bet account as the broker, you are open to make money on any of the financial instruments with which you may be familiar.
Not only this, but spread trading offers great leverage of your capital, no matter which market they are in. They really seem to be the trading instrument of the future.
Margin Trading
Spreadbetting allows traders and investors to trade on margin. In spread trading, margin permits you to trade depositing only a percentage of your trade’s total market value in your spread betting account. This enables investors to make a bigger profit or loss (of course they are hoping for a profit!) than the amount they put down on a trade.
You have the ability to bet per penny or point movement – the amount wagered is known as the stake and can be as little as £1 per point. It is important to understand that £1 bet on shares represents 100 shares (how many shares do you need to buy to make £1 if the share price goes up 1 penny? 100 shares).
So although traders are ‘betting’ as opposed to ‘buying’ shares, investors still get exposure to dividends – with the leverage advantage which can dramatically amplify gains (or losses). For instance a £10-a-point bet on a stock is the equivalent to holding 1000 shares in that company. For every penny the stock moves, you stand to gain £10, so if shares in Vodafone rise £1, you are in blue for a £1,000.
An example of margin in spread betting
If a trader acquires £5,000 of securities via a house broker, he normally has to pay the full £5,000 market value to do so. On the other hand, if you open a spread betting trading position worth £5,000 with a spread trading company, you may only have to pay between 5% and 20% – or £250 to £1000 to open the position. This deposit, which is required for each open position in your account, is referred to as the margin requirement.
When you open a position on your spread betting account must hold sufficient funds to cover the margin requirement. You must also take care to maintain the margin requirement deposit level in line with any unrealised profits/losses going through your spread betting account. If your margin deposit level falls below the margin threshold you will be required to deposit more funds or close or reduce one or more of your positions. Note that margin is there to protect you and the spread betting company – ensuring that traders don’t overstretch themselves.
Of course leverage can be dangerous and introduces more risk but more risk is just what many spreadbetters seek. And because these products have been developed with stop losses and guarantees, and much tighter spreads than they used to have, used sensibly and with a full understanding they may be the ideal sort of vehicle for frequent traders.
How it Works
In the stock market, when you want to deal in physical shares, you go to a stockbroker and they will quote you two prices. The lower of the two prices, which is the one you will pay if you are selling shares, is called the bid price. The higher quoted price is what you will have to pay if you are buying shares, is called the offer price. The difference between the two prices is called the ‘spread’.
In spread betting the principle is exactly the same, two quoted prices, bid and offer. If you believe the share price will go up, you buy at the offer price, also known as a long position or going long. If you believe the price will go down you sell at the bid price, also known as a short position or going short.
For instance, let’s take the FTSE 100. Say the FTSE 100 index is currently at 5782. You go long (buy) at £10 per point. In the next few weeks the FTSE moves 30 points to 5812 in the direction of your trade, when you decide to exit the position. You close the trade and make a gain of £300. This is because the FTSE 100 index has gone up 30 points in your favour, and your stake amounted to £10 per point, i.e. (5812-5782) x £10 = £300.
Standard Accounts and Limited Risk Accounts
Basically there are two types of spread trading accounts- a Standard Account and a Limited Risk Account. In a standard account, you have more freedom but you may have liable for losses that exceed your account balance (if you trade foolishly..) Sometimes you have to make a margin payment in order to maintain positions if the positions have moved against you. This happens because you have to meet the complete value of all running losses from your positions, in addition to initial margins that is needed to create the position. There are chances that you may lose more than your initial investment with a Standard Account.
For all those who have a poor appetite for risk, the Limited Risk Account is most suitable. Individuals are required to deposit appropriate funds in order to cover the maximum amount of loss before one is able to trade. For this you are required to place a Guaranteed Stop Loss every time you open a position. You have to choose a price at which the bet might be closed in case the market moves against you.
How much it Costs
You don’t pay any brokerage fees or commission and there’s no stamp duty to pay. And, with its unique tax status, you don’t pay any tax on any profits you may make. Remember, profits made by a UK resident from spread betting are exempt from UK Capital Gains Tax, stamp duty and income tax, however tax treatment depends on your individual circumstances and may change in the future.
When you spread bet, you don’t pay the full value of the instrument but, before you trade, you do need to deposit money in your trading account. This is what you’ll use to fund your trades.
You can then place bets with a deposit known as ‘initial margin’. The exact size of the margin depends on the type of instrument you’ve chosen to bet on, but it usually ranges from 1% to 10%.
Let’s look at a Vodafone trade example.
Let’s assume we’ve place a £10 per point bet at 130.60 pence. Say the margin requirement for Vodafone was 3% so our initial margin would be £39.18.
This is worked out by:
£10 x 130.60 offer (buy) price = £1,306
3% margin of £1,306 = £39.18, which means that our margin requirement to place this trade is £39.18
In any case my suggestion is read all you can on spread trading and start small..it can be a tricky business spreadbetting.
What about Financial Spread Betting and Tax?
Is Spread betting classed as ‘trading’ in the same way dealing with a conventional broker, and buying/selling shares on the open market is?
No, it is tax-free and you never actually own any assets, but from the point of view of mechanics and trading decisions its almost identical.
As mentioned earlier, financial spread betting is currently free of UK capital gains tax and stamp duty. Of course the legal environment could always change, but ‘till then, this will be one of the most attractive aspects of financial spread betting. After all, why bother going through a stock broker, paying commissions, stamp duty and capital gains tax (if you exceed your yearly tax allowence) when you can ‘trade the value’ of shares and other financial instruments tax free. Sounds too good to be true eh? Well there is a worthy note of caution here. Because financial spread betting is tax free, you aren’t afforded any of the tax protection or relief you can have access to when trading other financial instruments…every rose has it’s thorn after all.