Until relatively recently, spread betting was considered something of an anomaly in the financial world, with most consumers thinking of it as lesser to many standard investment products. As a result of increasing disclosure amongst fund managers and a growing public profile, financial spread betting has been transformed into a credible form of trading, with a variety of advantages to bring to the table. But compared to traditional share dealing, how do the pros and cons of spread trading weigh up?
Spread Betting
Financial spread betting is a bet on the financial markets, rather than an active purchase within them. Rather than buying 100 BA shares, a trader can take a spread on BA shares, declaring a stake per point, which is then multiplied by the number of points movement in the BA share price. If BA shares increase by 10 points, the trader will return 10 times his stake, whereas a loss of 10 points will incur and 10 x stake loss. Because of this multiplier function, traders can effectively increase their returns by many multiples in a tax efficient way without actually ever acquiring the underlying asset. However, spread betting is naturally a high-risk investment process, and one that is fraught with danger for even the most experienced trader.
Returns
Spread betting can undoubtedly deliver much larger returns over a shorter period of time than share dealing. Small percentage movements in share prices could deliver many times the return in the spread market, and the severity of the multiplier effect in spread betting means it quickly overtakes share dealing as far as earnings potential is concerned.
Say, for example, a trader buys 100 shares in Sony at 100p per share, on the assumption that Sony prices will rise in the near future. Suppose another trader takes on a £10 per point spread on Sony, 'buying' the shares at 101p with a spread of 98-101, on the assumption that Sony prices will rise.
If Sony share prices rise by 10% on the day, the return for the traders respectively would be as follows:
Share Transaction
Share gains = (100 shares x 110p per share) - (100 x 100p original share purchase)
Share gains = £110 - £100
Share gains = £10 - a 10% gain on the initial £100 share investment.
Spread Betting Transaction
Spread gains = (110p closing - 101 buy rate) x £10 per point stake
Spread gains = 9 points x £10
Spread gains = £90 - a 900% return on a much smaller upfront stake amount.
As you can see, in this instance the returns from spread trading far outstrip the returns available from actually owning the shares outright, and while there is rightly a great deal of financial media attention on spread trading at the moment, the enthusiasm must be tempered with the reality of the risks involved.
Risks
Where share dealing loses out in terms of the levels of returns it can bring, it wins outright on a cold risk analysis. The losses on any share transaction are limited to the value of the shares you have purchased. These will seldom become absolutely worthless, because they are tangible products that deliver a valuable right - the right to ownership in the underlying company. There will likely always be demand for purchasing your shares if you wish to liquidate your position at any time, and you can expect a share of any profits declared in the form of a dividend.
Contrast that with the risks posed by a spread trading position. If a spread betting position goes awry, the losses that can be sustained are as severe as the potential gains, and are theoretically unlimited - that means the broker can follow up for any losses you have sustained that can't be covered by the money deposited in your trading account. Similarly, because spread betting works on a per-point multiple basis, even small negative movements in price can be extremely costly.
Spread Betting
Financial spread betting is a bet on the financial markets, rather than an active purchase within them. Rather than buying 100 BA shares, a trader can take a spread on BA shares, declaring a stake per point, which is then multiplied by the number of points movement in the BA share price. If BA shares increase by 10 points, the trader will return 10 times his stake, whereas a loss of 10 points will incur and 10 x stake loss. Because of this multiplier function, traders can effectively increase their returns by many multiples in a tax efficient way without actually ever acquiring the underlying asset. However, spread betting is naturally a high-risk investment process, and one that is fraught with danger for even the most experienced trader.
Returns
Spread betting can undoubtedly deliver much larger returns over a shorter period of time than share dealing. Small percentage movements in share prices could deliver many times the return in the spread market, and the severity of the multiplier effect in spread betting means it quickly overtakes share dealing as far as earnings potential is concerned.
Say, for example, a trader buys 100 shares in Sony at 100p per share, on the assumption that Sony prices will rise in the near future. Suppose another trader takes on a £10 per point spread on Sony, 'buying' the shares at 101p with a spread of 98-101, on the assumption that Sony prices will rise.
If Sony share prices rise by 10% on the day, the return for the traders respectively would be as follows:
Share Transaction
Share gains = (100 shares x 110p per share) - (100 x 100p original share purchase)
Share gains = £110 - £100
Share gains = £10 - a 10% gain on the initial £100 share investment.
Spread Betting Transaction
Spread gains = (110p closing - 101 buy rate) x £10 per point stake
Spread gains = 9 points x £10
Spread gains = £90 - a 900% return on a much smaller upfront stake amount.
As you can see, in this instance the returns from spread trading far outstrip the returns available from actually owning the shares outright, and while there is rightly a great deal of financial media attention on spread trading at the moment, the enthusiasm must be tempered with the reality of the risks involved.
Risks
Where share dealing loses out in terms of the levels of returns it can bring, it wins outright on a cold risk analysis. The losses on any share transaction are limited to the value of the shares you have purchased. These will seldom become absolutely worthless, because they are tangible products that deliver a valuable right - the right to ownership in the underlying company. There will likely always be demand for purchasing your shares if you wish to liquidate your position at any time, and you can expect a share of any profits declared in the form of a dividend.
Contrast that with the risks posed by a spread trading position. If a spread betting position goes awry, the losses that can be sustained are as severe as the potential gains, and are theoretically unlimited - that means the broker can follow up for any losses you have sustained that can't be covered by the money deposited in your trading account. Similarly, because spread betting works on a per-point multiple basis, even small negative movements in price can be extremely costly.
