Spread Betting for Cautious Investors

I know that many “cautious” investors are put off spread betting because they perceive (or are encouraged to perceive) it as dangerous gambling. I think they’re wrong, and that spread betting need be no more dangerous than any other form of stock trading and investing.

Look at it this way:

  • If you invest £1000 in (for example) Barclays Bank shares at 200p-per-share, you’re risking £1000.
  • If you place a £5-per-point spread bet on Barclays Bank shares @ 200p-per-share with a spread betting company, you’re risking the same £1000 (because it’s £5 * 200 = £1000).
  • In both cases, if your chosen stock doubles in price, you make £1000 profit.

You took exactly the same risk for exactly the same reward on exactly the same stock in both scenarios, so what’s the difference and why is spread betting perceived as more dangerous?

The difference is that the stockbroker will ask you for £1000 plus a dealing fee (of around £10) to buy the shares. The spread betting company (let’s suppose IG Index) will ask you for a deposit of maybe just £100 to cover the risk-reward-equivalent spread bet, and will impose no dealing fee. This sounds like a good deal to me, so why is spread betting perceived as more dangerous?

It’s more dangerous if the novice spread bettor hasn’t realised that he bought £1000 worth of risk (which was no worse than on the share purchase) with his minimal £100 spread betting deposit. So he panics when his chosen stock goes bust and the spread betting company comes knocking for the remainder £900 that they were kind enough not to have asked him to deposit in the first place.

Once you’ve got your head around this simple fact about leverage — and if you can’t then you shouldn’t be dabbling with stock trading and investment at all — then spread betting really need be no more (or less) dangerous than traditional share dealing… providing you steer clear of day trading exotic currencies and commodities that you really don’t understand.

On the plus side you can hold “daily rolling” spread bets for as long as you want (for a negligible daily fee) rather like a share dealing investor or position trader, and even receive dividends like you would with a traditional share holding. You don’t pay dealing fees on spread bets, and any profits are currently tax-free in the UK.

I know that as an alternative to picking individual stocks, many traditional investors like to invest in index-tracking funds and exchange traded funds (ETFs) which almost track stock indices in a not-so-transparent fashion. In contrast, a spread bet on a major index like the FTSE100 tracks the index pretty much exactly. This sounds rather less dangerous to me, providing you understand that a £1-per-bet on the FTSE100 index at 5800 risks a full £5800 in exchange for your very much smaller deposit to the spread betting company.

With at least one spread betting company (okay, it’s Gekko Markets) you can dial down the leverage by dialling up the Effective Margin Rate so that a £1-per-point bet on the FTSE100 index really does require you to deposit the full £5800… just as you would have to in a traditional stockbroker account, stocks and shares ISA, or SIPP. See what I mean by noting the Trade value and Margin req. figures in the example Gekko trading ticket below.

Gekko Trading Ticket

This idea of spread betting being applicable (if approached correctly) to more cautious equity investors rather than merely day-trading “gamblers” underpins my Better Spread Betting book, so you know where to look if you need any more convincing. Oh, but please be careful, because all financial speculation is risky, even if it goes under the sensible-sounding name of “investment”.

Disclaimer: this posting is for general education only; it is not trading advice.