The idea of using spread betting techniques to gain exposure to the stock market, without having to take on the full risks of doing so, has for some time been growing in popularity. Financial spread betting dates back to 1974 when the IG Index was created to enable investors to trade the price of gold without incurring hefty premiums through the exchange controls applied if the actual metal itself was bought.

When it first hit the UK, financial spread betting was popular among institutional investors, city traders and high-rollers, but the process is now beginning to reach more widely and is used effectively even by smaller investors, particularly as a hedging
tool to profit from falling markets.

Tony Celentano, head of sales and business development at E*Trade, points out that ‘A wide range of investors will use spread betting for hedging purposes. If they have,
for example, a basket of FTSE 100 stocks or equities, spread betting can be a very cost-effective way of hedging that portfolio because there are no commission charges
and also very low set-up fees.’

Comparing like with like
When it comes to the actual mechanics of spread betting, the easiest way to explain it is by making a contrast with traditional betting. For example, if you place a £10 bet on a horse at 6-1 and your prediction proves correct (the horse wins), you would then win your original stake multiplied by the odds (£70). However, if your horse loses, then you forfeit your original £10 bet.

Spread betting is different in that you do not actually have to predict the exact result and the odds are not fixed. However, it can unfortunately result in very large losses, so it is essential that those who are new to spread betting do their homework
and start small, betting only with money that they can afford to lose.

‘Investors who choose to go down the spread-betting route must be very disciplined’, adds Celentano. ‘After all, it is a leveraged product. On going into any trade, all investors should always be working to a strategy. This could be based on pricing, fundamentals or risk exposure. Investors must also have their entry and exit levels in mind.’

Financial spread betting works primarily by predicting how financial market indices will react on a given day. For example, say you want to bet on the FTSE 100, which
is currently trading at 6,150. You are given a spread of 6,140 to 6,151 by a market-maker.

If you believe that the FTSE 100 will rise higher than 6,151, you then place an ‘up’ or ‘buy’ bet, placing a certain amount per point. Let us say you bet £10. If you are correct and the FTSE 100 rises to 6,225, you would make £740 (6225 minus 6151 = 74 points). However, if you were wrong and the FTSE 100 actually fell to 6,100, you would then have lost £510.

Strategic investing
When looking at the pros and cons of spread betting, investors tend to compare it with investing in shares, often coming to the conclusion that the latter is more ethically acceptable simply because spread betting has ‘down-market’ connotations.

Investors buy shares in a company because they believe that the price will rise over a period of time, resulting in them making a profit – hopefully a large one. What some fail to realise, however, is that spread betting is formed of exactly the same strategy, with the main difference being the reduced cost of trading shares as opposed to buying them.

But the main advantage of trading is the tax benefits. Because spread betting falls within the UK’s gaming laws, the ‘winnings’ are exempt from capital gains tax (CGT) and investors also benefit from not having to pay the 0.5 per cent stamp duty that they would otherwise have to pay with share transactions.

James Daly, investor centre representative at TD Waterhouse says, ‘Spread betting is a far more cost-effective option than buying shares. Making money, particularly in the present climate is hard enough.’

Margin trading
Another advantage, which also applies to contracts for difference (CFDs, see page 16), is the ability for investors to trade on margin – a particularly useful tool for those
who have limited capital. This basically means that by trading shares you have the potential of far greater returns, and, of course, far greater losses, than if you were to instead buy shares.

Spread betting firms allow you to place a bet with a deposit that is known as the initial margin. The exact size of this margin depends on the type of asset you have chosen
to bet on, but it usually works out at around ten per cent.

Daly explains, ‘This process is very similar to buying a house using a mortgage loan. In the worst-case scenario, your investment could go down to zero, but the whole mortgage would still be outstanding, not just the deposit that you originally put down when buying the house.’

He adds, ‘If you are trading BP shares at £3 per point, in terms of exposure, that would be the equivalent of buying 300 shares of BP. Normally that deal, not including any extra charges, would cost you £1,800. As a trader, in order to take out that position, you would only have to put down five or ten per cent of that. If you put down £180, the shares would only have to go down by 60p for you to lose your initial deposit or more. Similarly they could rise and you would make a profit.’

Limiting losses
Many people are put off spread betting because of the large potential losses. However, there are ways to become an active spread better without any of the sleepless nights.

James Parker, head of spread betting at ODL Securities, says, ‘An investor can place a guaranteed stop-loss on their trade so that if the market goes against them, they would have no further exposure beyond that particular level. About 70 per cent of our traders use a guaranteed stop loss.’

Trading veteran Vince Stanzione points out that a good trader does not necessarily need to make money every single time. ‘You could get 80 per cent of your trades wrong and still make money. Let’s say you lose £100 on eight trades and then make £500
on two trades, you are still in profit. However sure you are that the market will crash or XYZ is going to soar, make your first trade a small one, and then, if you are correct, add more to that trade.’

Spread betting can be a very addictive form of investing, both for losing traders who want to get even and winning traders that are on a roll, so it is important that, from the outset, investors know when to cut their losses.

‘Trading comes down to psychology: everyone wants to win and nobody likes to be wrong. Most unsuccessful traders take profits quickly while letting losing trades run and run hoping things will improve. Traders can spend too much time planning, when in fact they should spend much more time on the exit strategy and how much they are going to trade,’ says Stanzione.

Following the trend
In volatile markets, such as we are currently experiencing, prices can vary widely on a daily basis, an unnerving prospect for many ordinary share investors. But spread betting thrives in this environment and the more the markets move, the more money
can be made. According to Parker, ‘Spread betters look for quite sudden, sharp movements and we are seeing that in markets at the moment.’

The recent market turmoil has seen many trends come and go, with gold being one commodity that has dominated many a headline. Spread betting is a very diverse investment strategy, and Stanzione believes that the best trades are trends where a
trade is entered long or short and is left to run with the trend.

He enthuses, ‘Some of the best times to buy are when the crowd is terrified and there is blood on the streets. Markets go down because of lack of buyers. For a bull market to continue you need new money to keep the party going. If everyone is bullish on the market, then it has no other way to go but down as everyone that wanted to buy has already done so.’

There is another way…
The possibilities facing the spread better are vast, and the newest addition to this form of investing is binary betting. This is similar to a fixed-odds bet, but where odds are quoted on a scale between zero and 100 rather than in a fraction such as 2-1.

Let us take the FTSE again as an example. You have noticed that the FTSE has fallen, but think it may rise later in the day. The binary price for the FTSE to rise before the markets close is trading at 33 to 48. If you think that the FTSE will finish up at the end of the day, then you buy at 48 for a certain amount per point, let’s say £10. Conversely, if you think that it will finish down then sell at 38.

Your profits are calculated by taking the closing price minus the opening price multiplied by the size of your bet per point. In the instance that you placed a £10 per point bet on the FTSE rising before close – if you were correct then you would win £520 (100 minus 43 multiplied by £10 = £520). However, if the FTSE finished down then your losses would be £480.

Arguably, one of the key advantages to using binary betting over established forms of spread betting is that it gives you the opportunity to take advantage of non-volatile markets, as well as those that are frequently rising and falling.

With spread betting, your potential profits can be restricted if there is a lack of movement in the underlying market. By diversifying your trading strategies and opting for binary betting during these quiet periods, you could add to your winnings.