Beginner's Guide to Spread Betting
Introduction
How it Works - Similarities and Differences
Those with any experience of the financial markets will know the
process of opening and closing a position on the open market. For
example, if you were to purchase (or borrow in the case of shorting)
shares your broker would quote you a price. Once you complete the
transaction either by phone or electronically you would then take
physical ownership of the shares (however share certificates are
now held in street name).
This process of opening a position is the same should you wish
to place a spread bet. You can open bets by telephone or use the
on-line 'trading' platforms provided to you when you open an account.
The difference is that opening a spread bet position means that
you trade or invest in any of the instruments offered to you without
ever taking physical ownership of them. This is because, as we
have already mentioned, you are merely putting a bet on the direction
that you think they will move.
The fact that you never own a single share means that you forfeit
any voting rights attached to the stock. It does not mean that
you forfeit your right to a dividend payment however. Spread bet
firms will adjust you position higher for a dividend payment (and
mark it lower if a company goes ex dividend). At the time of writing
it is not clear if this is an industry wide standard so it is worth
checking with your chosen spread bet firm.
Shares vs. £ per Point
A fundamental difference in the way you place
a spread bet as apposed to an open market order is the quantity
you deal in. Rather than buying and selling no. of shares, you
will be operating in GBP (£) per point. The definition of one ‘point’ depends
on the spread bet firm in question but it is usually one pip in
forex and one penny (UK) or one cent (US) for shares. We will go
into detail in our examples section about how you can convert your
position size from £/ point to the equivalent of number of
shares or contract size.
Shorting
If you have ever traded during a bear market or an IPO you will
know that restrictions are placed on short positions. This is either
because brokers have no shares left available for shorts (am many
of their clients are already short) or the exchange has prohibited
shorting. There are no such restrictions when it comes to spread
betting. You are free to short (place a bet on price/ value falling)
as often as you like and during any market conditions.
Available Markets
Although you will not find restrictions on
your shorting activity there is a strong possibility of restrictions
on the number of instruments available to bet on. If you specialise
in penny shares, junk bonds or less liquid stocks you will more
than likely find yourself frustrated. Most spread betting firms
will offer you the opportunity to bet on mainstream indices (the
DJIA, S&P 500,
NASDAQ 100 and FTSE for example) and their member stocks. However,
lower valued stocks are likely not to be offered. For example you
will find yourself able to bet on the constituents of the NASDAQ
100 but members of the NASDAQ Composite are less frequently available.
Financial Incentives
We have already mentioned the tax benefits
associated with spread betting but there are also other financial
incentives. Spread betting firms charge no commission, there
are no ECN fess and exchange fees do not apply. Spread bet firms
make their money from the spread they charge. Therefore, the
larger the spread the greater your cost to trade. If we take
these firms at their word then they are constantly hedged in
the market against their clients ‘overall’ positions.
This means that they have no vested interest in seeing you make
a loss because they are not on the other side of the bet. In fact
they want to be profitable as it guarantees more bets (and the
cost of spread) for them. A less optimistic view is that spread
bet companies are no more than bookmakers and make their profit
based on the fact that the majority of traders (and gamblers) lose
money. This point will be discussed more in depth later on.
Summary
|
Can
open bets online or by phone |
No
physical ownership of securities |
Deal
in £ per point rather than number of shares or lot
size |
No
short trading restrictions |
There
is a limit to the markets available to speculate on |
No
tax, stamp duty or commissions |
Advanced
trading platforms |
Smaller
margin requirements, especially on stocks |
Trading Platforms
In order to make the spread betting experience as much like open
market trading as possible, spread bet firms have invested heavily
in their online trading platforms. These programs include live
streaming quotes, real time streaming charts
(including technical indicators
suitable for all but the most advanced technical traders), news
wires and order tickets featuring stop, limit, OCO, market and
CRB (controlled risk bets that act as a guaranteed stop loss) orders.
These platforms are provided at no extra cost when you open your
account, however features will vary depending on your provider.
Live Prices
The live streaming quotes are not fixed in order to catch you
out while betting. All quotes are based on the current market
price. The only difference is the spread as the spread bet firms
are free to set this themselves. As we have mentioned this is
their primary source of income and you may find spreads are a
little wider than you will find in the open market. However,
competition for your custom has been increasing rapidly and you
will find that the spreads on offer are very competitive.
Margin Requirements
Spread betting affords traders a much
lower margin requirement than typical share dealing accounts. For
example, SEC rules stipulate that brokers inside the US may only
provide leverage of 4:1 (25% margin) on accounts over $25 000.
This means that in order to command positions worth $100 000 you
must have a minimum of $25 000 in your account. With spread betting
firms the margin requirement is much lower. One leading spread
bet firm requires you to provide 5% margin for US share bets. Using
the same example a $100 000 position would only require $5 000
account balance. Of course this position would be calculated in £ per
point and not dollars. The relaxed margin requirements allow traders
to command much larger positions with their available account balance.
In theory this means a trader can achieve a much higher return
on capital but must do so by accepting much higher risk.
Contents:
1. Introduction
2. How it Works, Similarities and Differences
Next:
3. Examples
4. Gambling vs Trading
5. Summary
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