The majority of readers will be more than well aware of the concept of investing. Even if they are not incredibly knowledgeable, they will likely be aware of the FTSE 100, cash products, the UK 100 Cash and the concept of GBP/USD and EUR/USD. However, the term spread betting may not be as familiar. And even if it does ring a bell, there are likely a number of aspects regarding spread betting that you are unsure of. While many of us will fall into this boat, there are actually a large number of similarities between the two that you may be surprised to learn. Knowing both the similarities and differences between the aforementioned two can be incredibly beneficial for anyone who is looking to enter the financial market.
As a result of this knowledge, we decided that it would be a misstep on our behalf if we were to keep this information to ourselves. After all, spread betting has recently, and with ever-increasing speed, revealed itself to be a popular alternative to traditional buy-and-hold investing, so there is no point in trying to keep this from the realm of common knowledge. Instead, we have put this article together to introduce you to the world of spread betting by informing you of why it has more in common with traditional investing than you think! So, without further ado, let’s get started…
An Introduction to Spread Betting
So, let’s not waste any time. Whether or not you are familiar with spread betting doesn’t remove the need to break down and specify exactly what it is. By doing this, this article will have the ability to guide you through the actual similarities between it and traditional investing in a clear and concise manner.
Spread betting, in essence, is the act of speculating on the movement of a financial market without directly owning the underlying security. If one decides to enter the realm of spread betting, what they are doing is placing a bet on the change in price of a security. In order to do this, one goes through a spread betting platform as opposed to buying a security straight out.
So, in simple terms, when an individual bets on their prediction, they are not betting based on the fact that they have possession over the underlying security. Instead, they are simply betting on its price movement. One is simply speculating on the movement in price of a financial market, rather than investing in it directly by taking ownership.
Now that we have established an understanding of what spread betting is in basic terms, let’s take a look at what you can actually speculate on. Thankfully, when it comes to the financial instruments you can focus on, it is a similar choice to when you actually want to invest in a traditional sense. One can speculate on the price movement of, including but not limited to, commodities, forex, stocks and/or fixed income securities.
For example, if someone was to make a bet on one of the above financial instruments, the bet would hinge on whether or not the market rose or fell from the point in time the bet was made. The individual decides on which direction the market price will move as well as how much money they would like to risk on this choice. One of the main attractions of spread betting as opposed to traditional investing should be raised here. This act is both commission-free and tax-free, as well as being a leveraged product.
A leveraged product only needs a small percentage deposit, based on the position’s value, in order to qualify as spread betting. As a result of this, a spread bettor can potentially make more, but they can also lose more than what they chose to invest. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. Here, it is worth pointing out that before spread betting you should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
It should come as no surprise that taking a loss is possible, and neither should the fact that there are methods to limit the possibility of this happening. There are two main tools that you can establish, which give you control of your potential losses. Firstly, you can choose to initiate a stop-loss order from the outset, which allows automatic closure once the market reaches a certain point.
Secondly, there is a guaranteed stop-loss order, which guarantees closure of your trade at a pre-chosen specific value. While this is an incredibly secure option, there is usually an additional charge from your broker if you choose to make use of this tool. In order to take a look at spread betting in relation to its traditional counterpart, let’s now introduce buy-and-hold investing.
Traditional investing is the buying and holding of an asset for a prolonged period of time with the objective that it moves up in price. As this occurs, you have the option to sell it for profit based on the price you initially paid for it. Whereas spread betting uses leverage, traditional investing requires you to pay the value of the asset upfront and in full.
While this may appear initially as a disadvantage, and of course many people choose spread betting over traditional investing for this reason, it does ensure that you won’t lose a higher amount than you paid in. Furthermore, as you paid the full amount for the underlying asset, you own it, and therefore you are considered a shareholder with shareholder rights. This also ensures that you will receive a dividend payment if and when they are paid out.
Unlike with spread betting, you do have to pay CGT (Capital Gains Tax) as well as stamp duty on whatever profits you may make. So, while there are a number of differences between spread betting and traditional buy-and-hold investing, it is obvious to see that they exist within the same world, but with a different approach. Let’s now take a closer look at two of these differences in order to clarify what it is that separates them.
The Cost To Open A Position
We have already established that in order to open a position when traditionally investing, you have to pay the full value upfront, which then gives you ownership rights.
When it comes to spread betting, you do not have to do this. To specify, the average deposit when spread betting is around 23% of the total position size. Knowing this, as well as the risks involved with both, allows you to decide which is the best option for you as an individual.
Short Versus Long
When it comes to spread betting, you can go short. What does this mean, you ask? Well, it means that you can speculate on markets that are actively rising and failing. However, you are unable to go short when investing.
When you go long, you place a bet on an increase in the market price of an asset over a specified timeframe. To return to spread betting, going short is the opposite. You are able to speculate and bet that the market will decrease in value. When it comes to the terminology, you sell the market to go short, and buy the market to go long.
The Bottom Line
It is clear that while existing within the same world, there are differences between spread betting and traditional investing. There are clearly limitations to spread betting, while at the same time being much more accessible to a host of people. This, while being tax-free, is perhaps the biggest reason spread betting has grown to be as attractive as it is.
It is true that you do not have to pay the full price up front, but this of course means that you don’t ever own the underlying asset. One of the main benefits of actually owning the asset is the fact that if the price declines, you have the opportunity to hold on to the asset in anticipation that it recovers. Adversely, if this happens when spread betting, you may have to release your position due to margin factors and holding costs. This stops you from being able to wait for the asset to recover.
In this sense, spread betting is considered a form of short-term derivative trading. Whether it is long or short, you can speculate on price movements in the market. You do this by leveraging your access to the markets, depositing a percentage of the full trade value in the process. Ultimately, the spread is the difference in price between the point of purchase and the point of sale. Finally, your overall stake is measured by this difference.
In conclusion, the choice of whether you choose to invest in the traditional way or by spread betting is always up to you, the individual. There are clear similarities and, as a result, being aware of both the differences and the potential consequences of these differences is of vital importance. The aim of this article is to break down some of the advantages and disadvantages of both in order to allow you to make an informed decision.