As you’ll know, I’m a big fan of spread betting.
The spread betting phenomenon has opened up financial trading to many, many more people – it makes accessing the markets so fast, simple and – best of all – cheap!
But it does have its detractors – those who dismiss it as “gambling”, or as too risky.
In my view, financial spread betting can be explained as no more gambling than other investment. Fortunately, the Chancellor takes a different view, which is why it enjoys its tax-free status!
Of course, there’s an argument that if you can make something too cheap and too easy to access – but I’ll leave that debate to anyone stocking up on “buy one, get one free” beers at Tesco – That’s not to say that we can’t all still learn a thing or two about spread betting, so I thought I’d pass on a few points that you really should know if you’re a spread better…
Financial spread betting explained:
1. Long-term spread betters make more money
The statistics go something like this:
90 per cent of spread betters lose money… 90 per cent of spread betters use daily bets… Are you thinking what I’m thinking?
Spread betting is very well suited to short-term trading because you can deal in and out in small, cost-efficient ways. But that doesn’t mean that it’s restricted to day traders.
If trades run on overnight, your position will usually be rolled over automatically, and you’ll face a daily financing charge. But if you’re holding a position for weeks or months, you may want to consider using quarterly bets, which have a wider spread but not the financing chart.
David Jones of IG Index is quoted as saying that the spread betters who hold their positions longest make the most profit. Of course, this is a sweeping generalization, and don’t get me wrong – that doesn’t mean that you should just sit on your open positions until they show a profit.
There’s an old market adage that a long-term position is simply a short-term one that went wrong. What I’m talking about here are long-term strategies – these are the ones that look to follow big moves with the trend (as opposed to the day-trading strategies that scalp a few points here and there).
2. Spread betting can protect your investments
Many buy-and-hold investors use spread betting to hedge positions. There’s a lot of confusion and misinformation about “hedging”. And talk about wealthy hedge funds gives the impression that “hedging” is about making more money.
In fact, hedging is about insurance. And, no matter how many price comparison websites you look through – insurance always costs money. This is how spread betting might be used to hedge a position.
Let’s say that you own shares in XYZ company. You’re bullish about the company’s long-term prospects, but are worried about an earnings report about to come out and feel that the value of your shares might fall.
You don’t want to go through the hassle and cost of selling those shares and then buying them back at a later date. So, instead, you hedge your position by taking out a short spread-bet position on XYZ company.
That way, if the value of the shares go down, your spread bet will make up for the money you’ve lost on your shares. And, if you got it wrong and the value of the shares goes up in the short term – what you’ve lost on your spread bet will be made up for my the increased value of the shares.
For the time that your position is hedged – you’re not going to make any profits. But you have reduced your risk.
Of course, there are many, many ways to hedge a portfolio, and to reduce your risk exposure by different degrees, as well as “pairs trading” where investors aim to take a profit from both sides of their hedge. (More on that another day.)
3. You’re not betting against your broker
Many spread betters I speak to feel that they are locked in a bitter battle of nerves with their broker.
If you take out a bet at the bookies that number eight will win in the 2.30 at Newmarket – you’re betting directly with the bookmaker. If you win, they lose. If you lose, they win.
It’s not (necessarily) the same with your spread-betting broker. In principle, when you take out a spread-bet position, the spread-bet company will then go into the real market and take out a corresponding position in real stocks and shares, or currency (whatever instrument you’re trading).
So, if you BUY company XYZ on a spread-bet platform, your spread-bet company will go into the market and buy XYZ shares. In that way, they’re not taking on a risk from your position (they have hedged themselves). Their profits come from the cost of the spread and any financing charges.
That said, it doesn’t always work this way. Some spread-bet companies have a policy of hedging most of their business. Many do not. It comes down to the individual approach of each company and how they choose the balance the risk posed by your trades.
(The difficulty with hedging positions in the real market is one reason that spread-bet firms don’t like very short-term scalpers.)
Personally, I feel more confidence when I know that my position has been hedged and that there is no conflict of interest for my broker in giving me best execution.
Brokers tend not to be explicit about their hedging policy, but there are clues. If a firm is offering incredibly tight (or even zero) spreads, or are offering hefty financial incentives for you to trade with them – the likelihood is that they are making their profit in other ways.
There’s nothing wrong with this practise – it’s just helpful to understand better your relationship with your broker.
