Wondering why you should dip a toe into the world of spread betting? After all, if you think share prices will rise, why not just buy shares and have done with it? Well, one of the answers as to why spread betting can be better is gearing. So, what is it and why is it such a powerful tool in the right hands (and something of a catastrophe in the wrong ones)?
Gearing or 'leverage' is the ability to place a large bet with a small outlay. That magnifies normal profits and losses on a trade.
Say you buy 1,000 shares for £2 each. Your outlay is £2,000. If the shares rise 10% to £2.20 and you sell, you take away a 10% profit. Not bad. But now look at what a spread bet can achieve.
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Let's say you decide to bet on the same share at £10 per point via a spread betting broker (we'll ignore bid to offer spreads throughout these examples for the sake of illustration). So you place an upbet ('go long') at £2 and let's say the share rises to £2.20 as before. Your profit in spread betting terms is 20p - or £200 at £10 per point (20 x £10). So far, that's the same profit as you would have made by buying and selling the shares. But there's a crucial difference.
To open the spread bet, your broker might have asked you for say a 10% deposit. This would be based on the size of the opening position and its relative risk (ie, the volatility of the share you bet on). So that's a £200 deposit (10% x £2,000). That means your return on investment is 100% as you put down £200 and made £200. This beats a decent but steadier return of 10% (£200 as a percentage of £2,000) when you bought the shares).
And that's not all. Spread betting gains are tax-free. Sure, so are gains on shares held via an ISA but only up to the annual investment limit (currently £10,680).
Now for the drawback. If the shares above had fallen 10%, as a shareholder you could wait and see whether they recover or cash in and say goodbye to 10% of your initial outlay. But get a spread bet wrong to the same extent and the £20 drop in the share price triggers a £200 loss at £10 per point. That wipes out your deposit. So the final tip for spread betters is to learn about stop losses before trading as these limit the damage when a bet backfires.
Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.
He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.
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