Spread betting
Spread betting is one financial venture that definitely requires a health warning – it has been described as the ‘crack cocaine of investing’.
This is definitely not a punt for the financially naïve or foolhardy – note that it’s called spread BETTING not INVESTING. But these days you can place stops on your bets to prevent money bleeding uncontrollably, so let’s see how it works.
Spread betting originated to offer a range of outcomes on a given event, whether it’s the result of a football match, the price of gold or, most popular in Britain currently, the movement of the stock market.
It allows punters to either bet that the index will rise, which is called ‘buying’ in the parlance. Or that it will fall, which is called a ‘sell’. The advantage for the broker offering the spread bet is that he is able to take bets in a falling market.
And by taking bets on both sides of the market, the losers will tend to cancel out the winners. Meanwhile, he’s making his profit on the difference between the buy and sell prices … the spread in other words.
An example makes things clearer. Say the FTSE is trading at 5998. The broker might set his estimate at where the index will finish the day at 5996-6000 points. This is a four-point spread, with the lower figure (5996) being the sell price and the higher (6000), the buy price. Now let’s say you have done your research and you reckon the FTSE is going to fall. You wager £10 a point on that outcome. You now ‘Sell’ at 5996, which simply means you’re placing your bet at that price.
Hurrah! You got it right, and the FTSE dips to 5950 at the close. Your broker is now offering a spread of 5948-5952. You decide to cash in your chips. To do so you have to BUY at the new buying price, ie 5952. Subtract this new buy price from your original sell price – that’s 5996 minus 5952. 44 points at £10 a point, or £440.
Your pal, meanwhile, had bet that the FTSE would rise, and made a ‘buy’ bet at 6000. But every point the index falls below his buy price costs him £10. He closes at the new ‘sell’ price of 5948, a loss of 52 points and £520.
It would work exactly the same way, but in reverse of course, if the market rose. The thing to remember is that ‘buy’ bets are always cashed in at the ‘sell’ price, and vice versa. The sharp eyed will have noticed that, with the way the ‘buy’ and ‘sell’ prices are set, the system ALWAYS favours the broker. The bookie (for that is what he is) always pays less to the winners than he snatches from the losers. This spread is where he makes his money.
Also note that while your gains are, theoretically, limitless, SO are your losses. In practice though, rather than letting the bet run, people can limit their losses, either by electing to close the bet at ANY TIME, or by setting a Stop-Loss mark at which the bet will automatically close.
You then have to settle at the SELL OR BUY price the broker’s offering at that time. Note that you don’t set a limit on your potential winnings … though how far you want to let a winning bet run depends on how strong your nerves are.
It could be a day, or you could let a SELL bet run for months if you think the market’s going to keep falling.
Okay, you realise by now that spread betting isn’t for the faint hearted. But it CAN play a serious role in a financial portfolio.
First, it’s a way of hedging your bets. If you have money invested in the stock market, you’re presumably investing in the hope that it will rise. Placing a ‘sell’ bet on the FTSE means that if it falls, you STILL gain. You’re backing both sides of the market.
It also means you can invest in a huge range of financial products – there are spreads on sports fixtures and property prices, on commodities and individual stocks as well as on stock market indices around the world. If it exists, you can probably place a spread bet on it.
With financial spreads, you’re exposing yourself to the stockmarket without actually buying shares – so no share dealing costs and no capital gains or income tax to pay on gains.
It’s also, undeniably, exciting … though the excitement of gambling can lead you into deep waters as you attempt to recoup losses. Approach with caution!
