Return of the Day Trader – How Financial Spreads Enabled Day Traders to Flourish
By Jonathan Russell
Monday, 13th July 2009
In many ways spread betting has come to epitomise the City of London and its workers. A high-risk, high-reward, tax-efficient way of gambling on almost anything the human imagination can invent.
Loaded with jargon, the industry feels like a closed shop to the outsider, even those who occasionally enjoy the odd flutter on the horses. Spread betters buy or sell an index instead of placing a bet. Confusingly to the outsider, this can also be known as going long or short.
They "trade" instead of simply laying a bet and once the bet is live they "hold a position". But despite the confusing terminology, the reality of spread betting is based on the same principles as ordinary gambling, or many investment techniques.
Money is put at risk in the expectation, or hope, of a certain outcome occurring, resulting in a return on that investment.
Andrew Mackenzie, of UK spread betting company Spreadex, explains: "To the uninitiated the concept may initially appear daunting, but the basic principle of trading by 'buying' or 'selling' an interest in the price movement of global shares or the world markets remains relatively simple.
"Spread-betting firms offer a prediction or 'spread' of where they think a particular share or index will close at a given time, allowing individuals to trade or bet on the accuracy of that estimation. People who think a prediction may be too low can 'buy' on the price, whereas those who think the spread is too high can 'sell'."
As Mr Mackenzie explains, this principle can extend to almost any activity. In the recent Budget speech bookies were offering spreads on the number of times Chancellor Alistair Darling would say "sorry" or take a sip of water. If the punter thought the predictions were too low or too high, he or she could take the converse bet.
Although these novelty bets attract much media attention, spread betting operates primarily in the financial markets – shares, commodity prices or interest rates. Even sports bets take a secondary position to the financial markets.
To explain how it works, Mr Mackenzie uses an example: "Let's say Tesco opened the day at 358p and you want to speculate on the movement of the shares in the short term. You see a quote of 351p to 352p, the 'spread' from one firm, but you think the share will end higher so you decide to buy at £100 per penny movement at 352p.
"If Tesco ends the day up at 360p, that's eight points higher than the firm's buy price – meaning you win £800. However, if Tesco ended the day down two points from the buy price at 350p, you would have to pay £200."
The attraction in this form of speculation over investing directly in shares is that gains are tax-free, there is no stamp duty payable and for a large outlay the capital required can be relatively small, which is particularly useful in the current financial environment when debt is hard to come by.
To create the same exposure outlined above by buying Tesco shares, an investor would have to part with roughly £35,200.
But the attraction of relatively small sums for a large exposure can also lead to huge losses. With some spread-betting companies requiring deposits from as little as 3pc of the equivalent direct investment value, it needs little more than a marginal movement in the share price in the wrong direction to leave the punter owing the bookie substantial amounts of money.
In the example above, a 6pc slide in the share price from the buy price would leave the punter owing more than £1,000 after losing his initial deposit of £1,200. For this reason, "stop loss" triggers can be introduced, mechanisms whereby a bet is automatically closed if a share price reaches a certain level, effectively limiting any loss.
With the stakes so high, it is important to take note of other ways to limit losses. Simon Denham, of Capital Spreads, advises: "Do not commit too much of your available funds to just one position.
"If you were running a hedge fund and you made a return of 30pc over one year, you would be invited to smart dinner parties, journalists would want to ask your opinion and analysts would be trying to decipher your positions for indications of impending market direction. But many of our clients try to double their money in just one day.
"Sometimes they succeed, then they try to do the same the next day and then the next.
"The problem with this method is that you are risking all your money every time you trade and therefore you must get it right every time. If you fail just once then, bang, you lose everything. In 24 years of trading, I have never met a dealer who gets it right every time."
With so much at stake it is little surprise the industry is regulated, although this is done by the Financial Services Authority rather than the Gambling Commission. However, this will be little comfort to those punters who have simply lost their money after making losing bets.
Mr Denham said: "While spread betting companies are unanimous in stating that they are happy to have winning clients, this should not be confused with thinking that they are on your side.
"In the financial world, for every winner there must be a loser."
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