Spread betting comes of age

More and more investors are turning to spread betting as a way to make money. Cris Sholto Heaton explains why, and outlines the risks involved.

Spread betting grew strongly in popularity in the years after the global financial crisis, as high volatility and low expectations of steady capital gains saw traders look for alternative ways to make money.

The number of people placing at least one spread bet a year or using contracts for difference (CFDs), a similar instrument peaked at more than 100,000 in 2012, according to research firm Investments Trends.

Given that stocks have recently begun performing more consistently the FTSE 100 was up a healthy 14% last year one might have expected that number to drop off significantly by now. But so far, there's not much sign of this.Activity has shrunk a little, but some 93,000 traders remained active in spread bets and CFDs in 2013.

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In short, spread betting appears to have established itself as part of the mainstream within the UK investment community, rather than simply being a passing fad.

That's not surprising, since spread betting is more of a complement to traditional methods of investing than a competitor. Many investors will have a mix of long-term and short-term positions in their portfolio at any one time.

Spread betting is entirely unsuitable for the former, but has four key features that may sometimes make it a better choice for the latter. The first is tax.

Profits from spread betting are currently tax-free, whereas profits from dealing directly in shares are subject to capital gains tax (CGT). For smaller traders whose gains would probably be covered by the annual CGT allowance, that's not a big deal, but it can be attractive for larger ones.

The second is costs. When you deal in shares, you pay dealing commission perhaps £10 a trade. With spread bets, you don't all the costs are absorbed into the spread'. Yes, you're certainly still paying your spread betting provider, but you're doing so in a way that can make smaller or more frequent trades more cost effective than buying directly.

The third is market access. Spread betting doesn't just let you trade shares you can speculate on a wide range of other assets, such as currencies and commodities. Importantly, you can go short meaning that you bet on them falling just as easily as you can profit from them going up.

And lastly, there's leverage, which is perhaps spread betting's greatest selling point and its greatest risk. Leverage means that you trade with borrowed money, which can increase your profits when you get things right but will also cause you to lose money when you get things wrong.

And make no mistake: you will get things wrong. Even the most successful traders don't have anything close to a 100% hit rate. Beginners will do far worse unless they are very lucky, in which case they are likely to get overconfident and suffer even more when their luck turns.

For this reason, new entrants to spread betting should tread carefully. If you have an addictive personality or see spread betting as a quick way out of money troubles, don't even consider it.

Practise extensively with a demo account first, start small, be realistic and master risk management early. And if you're still consistently losing money, accept that trading may not be for you and be prepared to give up.

On that cautionary note, good luck!

Cris Sholto Heaton

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.