Spread betting is another way of buying and selling shares. Instead of buying the actual stock when we purchase through our broker, in spread betting we are literally placing a bet on the stock that it will either rise or fall as defined by the spread.
The spread is the price to buy and the price to sell, and with spread betting we are wagering money in the outcome. For example, a stock may be 190p to buy and 188p to sell – we might ‘bet’ that the stock goes up by placing a certain amount of money on the stock going up, buying at 190p.
Despite spread betting being a way of gaining exposure to a stock – the rates for failure when trading leveraged products such as spread bets is extremely high. Due to new European Securities and Markets Authority (ESMA) regulation, spread betting firms now have to include how many of its clients lose when trading these products. A quick scan of the most popular spread betting firms showed all of them having more losing clients than winners, with most around 75% of losing clients.
Why should you spread bet?
Because so many traders lose when spread betting any profit is currently not taxed. The government classes it as ‘gambling’. That means we can make as much money as we can in our spread bet accounts, and withdraw any profits with no issues. With ISAs and spread betting, there is no reason why any private investor should be paying tax on their investments. The only exception to this is if one takes an equity placing – the stock must be bought in a non-ISA account – meaning that profits on the placement stock are taxable. However, there are ways around this. By selling the stock in our share dealing accounts once it has settled and rebuying the stock in our ISA accounts at the same time means we transfer our exposure into a tax-free wrapper account. This trick is called a bed and ISA. We can also transfer this to a spread bet provider if we do not have sufficient cash in the ISA.
Margin calls
One of the dangers of spread betting and trading other leveraged products such as CFDs is that we can trade and be exposed to positions that are worth more than the value or our cash deposited. For retail traders and investors (those who have not upgraded to professional) most stocks that are available to trade are at least 25% margin. This means that on a £10,000 position we would be required to have at least £2,500 of cash on account.
Trading on margin magnifies our gains and losses. For example, if a £10,000 position on 25% margin went up 25% then we would have made 100% on our capital deposited. But if that same position dropped 25% then our capital would’ve been fully wiped out.
Another part of the ESMA regulation that was introduced in 2018 is that negative equity accounts are no longer allowed for retail investors and traders. This is a good thing for gamblers, as many punters were owing thousands to spread bet firms because they had pressed some buttons and taken positions that were way in excess of what they realistically could afford. With some margin rates for stocks available at 5% deposit, this meant that the position exposed was 20x higher than the original cash deposit!
Whilst many small and mid-cap stocks on the London Stock Exchange are typically around 20-25% margin, this can change and is completely at the discretion of your spread bet provider. They can increase margin whenever they like, for whatever reason, so always be aware of this fact because you could suddenly receive a request for more cash on account.
Guaranteed stops
One feature of spread betting is that some providers now offer guaranteed stops. This means that one can protect a position by placing a guaranteed stop during market hours. You can take the stop off outside of market hours, but you can’t put one on or edit it closer to your position. No doubt this is because if there is news to the downside, everyone would just change their guaranteed stop right up to protect themselves.
IG also used to offer very tight guaranteed stops, whereas now they have to be a certain amount away from the spread. This is because traders would game the system on stocks that had dividends. One could simply place a guaranteed stop just below the spread, and on an ex-dividend date the stock would gap down the next morning, only the trader would get a guaranteed stop way above the opening price as well as receiving the dividend. Needless to say – IG soon put a stop to such shenanigans.
Regardless, guaranteed stops are very useful because they offer guaranteed protection in the case of a profit warning. Guaranteed stops often have an extra premium on them should they be triggered – but if a guaranteed stop is triggered and it costs you an extra 1% and saves you 30% as the price is gapping down on the open then it is a price worth paying.
However, guaranteed stops do not protect you if a stock delists.
Why should I not just spread bet?
Many ask me why they should not just solely spread bet if it’s completely tax free. The answer is because spread betting, whilst similar to stock trading in that it mimics the underlying asset of a stock, is not stock trading. Spread betting is “commission free”, but the spreads are wider when spread betting to compensate for that and more. Spread betting also charges a daily funding rate for positions, whereas there are no fees for holding stock in an ISA. Another reason is that most people can’t handle their leverage – the statistics from all spread betting firms back this up yet many believe that for them it will be different.
Spread betting is a tool
I believe that spread betting is a useful weapon in the trader’s arsenal. It has its advantages and disadvantages like everything, but so long as one understands the risks properly then it can used as a tool to lever up.
However, if you are not profitably trading already then I would suggest to avoid spread betting. If you can’t make profits with the money you have, why would taking on extra capital and risk be a good idea? This is the big danger with spread betting. Just because we can take oversized positions, doesn’t mean we should.
Key takeaways
- Spread betting is a tax-free tool for traders because the government classes it as gambling
- Spread bets mirror the underlying asset
- Spread bets use leverage which can be dangerous if used incorrectly
- You can read more on spread betting here and learn the steps to successful spread betting here
Michael Taylor
Michael has released his UK Online Stock Trading Course sharing his knowledge and how he trades the stock market. ShareScope & SharePad subscribers can take advantage of an introductory offer by visiting www.shiftingshares.com/online-stock-trading-course
Twitter: @shiftingshares
