Diary Of A Private Investor

In these days of volatile stock markets, there's one way to stay in the game and still reduce the risks of heavy losses to a minimum
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The Independent Online

To get away from the horrendous events in America last Tuesday, let me tell you a true story: Once upon a long time ago the building society and I bought a small detached home on a new housing estate in Albrighton, Shropshire. The custom in those days was for the builder to turf the front garden but to leave the back garden as a sea of mud and brick-ends.

My new neighbour, an ambitious and thrusting young engineer who, in a moment of lust he was obviously beginning to regret, had married a beautiful but very dippy blonde, spent every weekend for a month clearing and levelling his rear patch ready for grassing. When it was finally ready he instructed his wife to order a delivery of 15 square yards of turf. Where did she go? To the turf accountants in the high street.

I remembered this perfectly true tale as I read the e-mails this week that were provoked by my declared intent in last week's diary to dip my toes into the spread-betting waters. The Colonel Blimps who blustered that such speculative gambling was far removed from stockmarket investing were far outnumbered by those readers who asked for more information. Like my blonde neighbour, they're not too sure how this betting business works.

To put the matter into perspective, I must emphasise again that spread betting is different from equity investment. You do not acquire shares and you are not a part-owner of a company. Spread betting is purely a short-term gamble on the price movement of a share or any number of other financial instruments. In normal circumstances I would not consider or recommend such an activity for private investors. But, as the recent plunge in world markets illustrates only too well, circumstances are not normal. At times like these it may pay you to learn new tricks.

The basic concept of a spread bet is simple but, perhaps surprisingly, some investors take a while to understand how it works. This may be because they mix it up with the rules governing options, derivatives, and other seemingly complicated financial instruments. So the first thing to do is to clear your mind of everything and pretend you are learning a new game. I am the bookmaker and you are the customer.

First scenario

Me: Hello, Mr Punter. What can I do for you today?

You: I believe the price of ABC company shares will rise and I want to place a bet on it.

Me: No problem. The spread on ABC shares today is 150 to 155. This means, if you believe the share price will rise, you can buy at 155 and, if the price rises beyond that figure at any time in the next three months (or six months, whichever you choose), you will be a winner when you decide to close the bet.

But if it drops below 155 you will be a loser.

Now Mr. Punter, how much would you like to bet?

You: I will bet £10 per point please.

Me: Thank you. Just to make it quite clear, if the ABC price rises by 45p to 200p you will win £450. But if the price drops by 55p to 100p you will lose £550.

Second scenario

You: I believe the price of ABC share will fall and I want to place a bet on it.

Me: Certainly, sir. The spread on ABC shares today is 150 to 155. This means, if you believe the share price will fall, you can "sell" to me at 150 and, if the share price falls below that figure any time in the next three months or six months, you will be a winner when you decide to close the bet. But if it goes higher than 150 you will be a loser.

Now Mr. Punter, how much would you like to bet?

You: I will bet £10 per point please.

Me: Thank you. Just to make it quite clear, if the ABC price falls by 50p to 100p you will win £500. But if the ABC price rises to 200p you will lose £500.

That is my Janet-and-John explanation of how it works. There is not the space to explain it in greater detail. If you contact one of the seven spread-betting companies in the UK they will send you their glossy brochures which give a host of instances, and the bookmakers all have helplines to cope with your queries. The upside of spread betting includes no capital gains tax on winnings, and no stamp duty or broker's commissions on deals. The bookie makes his money on the spread difference and even pays the betting tax for you.

The downside is that, unless you use a stop-loss system – and I strongly advise you do – large losses can quickly happen. Also, losses cannot be offset against your annual CGT liability.

A note from The Independent's Personal Finance editor, William Kay, mirrored the question most of you asked after my declaration that I was planned to place a spread bet. "You say you can identify share prices that are going to fall dramatically," he said. "How do you do that? I think we should be told.."

My technique is simple. I will adopt exactly the reverse criteria to those I use to identify shares which I believe are going to increase in value. This means I will look for companies with a comparatively high PER (price-earnings ratio), high borrowings, poor interest cover, low asset value and a high PSR (price-to-sales ratio).

Having compiled a list of likely candidates I read as much as I can about each company, and in particular the last statements made by the chairman and the most recent news stories. I then apply the common sense factor. Will the company be adversely affected in any way by the present economic climate? I have already found a candidate that fits the rather depressing scenario.

So that's my system. I only hope it works.

terry.bond@hemscott.net

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