Want to beat the market? Then spread your bets

Amateurs and day traders are being attracted to a former preserve of City professionals, says Jenne Mannion

Stockbrokers are hurting badly from a lack of business as investors lose enthusiasm for shares. Some of that money is being diverted into spread betting, which continues to surge in popularity well beyond the confines of City traders.

Stockbrokers are hurting badly from a lack of business as investors lose enthusiasm for shares. Some of that money is being diverted into spread betting, which continues to surge in popularity well beyond the confines of City traders.

Although it was originally the domain of City professionals who would bet on the movement of financial markets and currencies, spread betting is now thriving among day traders and amateurs.

Dan Moczulski, head of new business at IG Index - one of the first providers of spread betting services - says his company has experienced an annual 25 per cent rise in new accounts in recent years.

Even more telling is the rise in the number of companies offering the service. Three years ago there were only three main spread betting companies, Cantor, City Index and IG Index, based in London. That figure has since trebled and all the new entrants have been highly successful.

Financial spread betting works by betting that a certain stock market index, individual share, currency or commodity price, for example, will rise or fall in value. In essence, you are betting on the derivative-based futures markets of a certain financial product.

You can even spread-bet on house prices. IG Index enables you to bet on average prices (as reported by the Halifax Survey) for the UK as a whole, London and 11 other regions.

Simon Denham, managing director of Capital Spreads, a new City-based spread betting company formed last year, said the most popular spread betting instruments currently at his company are the Dow Jones index in the US, and foreign exchange markets. But different financial instruments swing in and out of favour for spread betting according to the direction of markets and their volatility. Spread betting works by a company quoting a range at which it expects that financial instrument will end on a given date. This range is known as the spread, and is the difference between the buy and sell price, which is in turn linked to the actual futures market for that financial instrument.

The client will then take a bet on whether the outcome will be higher or lower than that company's spread prediction. The more correct you are, the more you will gain. With an index you may bet £1 per point for any rise over the buying quote: the more points that the index rises by, the bigger your win.

The same concept applies to shares, except that instead of betting £1 or more per point, you bet per penny of the share price. The stakes can be higher than £1 if you want.

Be warned however that this is not a one-way bet - you could be left nursing severe losses if you make the wrong decision and the market moves in the opposite direction to the one you have predicted. If an index goes down 100 points from your buying price, or a share price goes down 100p, you will lose £100 at £1 a time.

A characteristic of spread bets is their set expiry date, which is linked to the particular futures contract and therefore varies among different financial instruments. For example, with commodities futures the expiry date will be a certain day of the month, while shares typically expire at the end of each quarter (March, June, September and December)

When your bet expires, you have the option of realising your gain or loss, or rolling over the bet for a further period. Mr Denham said there is a small cost involved in rolling over a bet - generally around 0.25 per cent. Although there is always an expiry date, you are not locked in and can cash in, or cut your losses, at any time.

Certainly, spread betting has gained popularity because it offers many advantages, including the fact you do not pay stamp duty and gains are tax free. Though, remember, this also means you cannot offset losses against tax.

And unlike traditional share or index-based investing where profits depend on rises in a certain stock or market, spread betting enables you to profit from falls.

Ian Jenkins, head of financial spread betting at Cantor Index, said: "At the moment a lot of people are finding it easier to find dog stocks than good stocks and are making money this way, by saying the price will go down. This is one of the reasons behind the surge in interest."

While spread betting enables punters to make money in their own right, it has also become a popular method for more long-term investors to hedge their existing share portfolios. If you have some shares that are decreasing in value in the short term, you could sell the value of the share with a spread betting company and make a profit to counter-balance the decreasing value of your shares.

A further advantage is the potential to magnify your return on an investment, meaning a smaller outlay is required to achieve the same result. In terms of spread betting on equities, a £10 bet provides the equivalent profit of holding 1,000 shares in a company, irrespective of their value.

Mr Jenkins gives the example of buying 1,000 traditional BT shares. For every penny that the BT share price gained, the total value of that pot of shares would rise by £10. If BT shares were trading at 400p each, that would involve a £4,000 outlay to buy the 1,000 shares. However, achieving the same £10 gain based on each share rising by a penny, would require an outlay of as little as £100 under a spread betting arrangement.

It is vital to remember though that spread betting can be risky business and you can be liable to pay out more than your initial outlay if you make the wrong decision and the financial instrument does not move in your favour. In the BT example, although you only parted with £100, you could foot a much bigger bill if the price went down.

Mr Jenkins says while you may be required to pay out more than your initial stake, you can't lose more than if you had, for example, bought the shares or index directly.

Take the BT example again. If the 1,000 shares bought at 400p became worthless, then the total loss incurred by the investor would amount to £4,000. Likewise, with spread betting, although the initial outlay was a lesser £100, you would still only be liable for the same £4,000 in the event that the BT shares became worthless, Mr Jenkins says.

The difference is that the investor in shares has already laid out the money, whereas the spread betting punter may have to pay the additional funds to cover losses in excess of the initial funds deposited. Therefore you do stand to lose more than your initial funds through spread betting.

One way to reduce the likelihood of these steep losses is by setting predetermined stop loss limits on your bets, a service offered by many spread betting companies and an advisable move for those wanting to limit potential falls. Some, such as Capital Spreads, enforce these stop loss limits. "It is in our interest that our clients are aware of their liability in the event of the markets moving unfavourably," Mr Denham says.

Spread bets are often confused with their closely related cousins Contracts For Difference (CFDs). A key difference is that as spread bets are classed as gambling, so there is no stamp duty or capital gains tax. Spread bets are less flexible: they have set expiry dates while a CFD can theoretically be held for ever.

The bid-offer quote, or spread, on a CFD is likely to be narrower than the spread on the equivalent spread bet, which helps the company to reduce trading costs. However, investors pay commission on CFD trades, which is not incurred on spread bets.

While financial instruments account for the lion's share of the spread betting market, it can also offer spice to sporting events, including football, cricket, horse racing, snooker, dogs and boxing to name just a few. Spread betting companies pulled in millions of pounds in profits on bets during the Euro 2004 football championships.

Many traditional spread betting companies such as Cantor and IG Index have opened sporting arms to their operations, but traditional bookmakers such as William Hill are also entering this market, offering an alternative to their fixed-odds betting.

Although it has a different flavour, sport spread betting follows the same concept as financial spread betting. A prediction is made by a bookmaker regarding a specific aspect of a sporting event. This could be how many goals will be scored in a football match, or the time of the first goal. The punter then decides whether the guess is too high or too low and loses or gains accordingly.

Better still, you can gain from predicting that an individual or team will perform poorly rather than backing their success. There are also many specialist bets, such as the number of yellow cards or corners in a game of football, or runs by a named cricketer.

Additionally, many markets offer live prices: as the sporting event progresses the spread is updated accordingly. This allows you to take profits or cut losses before the end of the event.

It is easy to get started with spread betting. All you need to do is open an online account with the provider of your choice. This can take just 10 minutes and you will need to have your bank account details ready. You do not need big sums to invest. In terms of financial spread betting, you can get started with a deposit of as little as £10, the minimum trade allowed by Capital Spreads. Most other companies require bigger investments, starting at £250.

However, while setting up an account is relatively simple, all would-be punters should research in great detail the sporting events or financial instruments they want to pursue, and truly understand the risks. As with all forms of betting, you should only commit yourself to what you can afford to lose. As the losses may be bigger than your initial bet, bear in mind the maximum loss or set stop-loss limits.

The spread betting companies are likely to reinforce this message when you sign up for an account. The Financial Services Authority (FSA), the City regulator, issued a warning to firms this month that they must clean up their act to protect investors. The FSA criticised firms for luring customers with hard-hitting promotions without sufficiently highlighting the risks.

The concern was that many people might fail to realise they could end up paying far more than their original stake if the markets dramatically changed against them, or if the score in a sporting event was far higher or lower than expected.

HOW TO PLAY THE SPREAD BETTING GAME

The amount you bet is known as the stake. You can bet per penny or point movement when spread betting.

Rachel Woodford, marketing director at Capital Spreads, said the spread refers to the sell (bid) and buy (offer) prices quoted by the company.

This price is calculated by adding points around the live (or the estimated future) market price of a financial product. The prices are set by the spread betting company and based on the underlying market. If the December FTSE 100 futures contract is trading at 4,314, the spread betting company might quote 4312-4316.

This quote offers two options to punters: the opportunity to bet the FTSE will rise or fall in the next few months.

For every point or penny that the market or stock moves in your favour, you will win that multiple of your stake.

If the market moves in the opposite direction, you lose the stake multiplied by the number of points or pennies of movement.

AS TAX-EFFICIENT AS WALKING INTO A BETTING SHOP

Spread betting is a highly tax-efficient and cost-effective way to make money from financial markets.

There is no requirement to pay stamp duty on spread betting because you own derivatives rather than the physical financial instrument itself. By contrast, shares attract stamp duty of 0.5 per cent.

Spread betting is regarded by the Inland Revenue as a bet - similar to walking into a betting shop and placing money on the races - so any winnings are free of income and capital gains tax. If you profit on traditional shares, you could be required to pay capital gains tax on gains exceeding a threshold of £8,200 in 2004-2005. This is one of the attractive features of spread betting. However, that also means any losses you make on spread betting cannot be used to offset a capital gains tax liability.

And there is no broker commission on trades. The spread betting companies make their profits through a complex system of hedging their clients' bets on the futures markets.

'My gains are becoming more frequent'

Matthew Ramsden, sales manager for a small London-based publishing company, started spread betting in April by setting up an account with IG Index. He later opened another account with Spreadright, a sister company of IG index that allows smaller bets.

Mr Ramsden, 32, from West Yorkshire says spread betting appeals to him because only a small amount of money needs to be put down to make a sizeable gain. He also likes the idea of being able to bet that stocks will fall, rather than just rise.

Although he is currently down by £800 he claims he has learnt a lot and is not disheartened by the loss. "My gains are becoming more frequent now, and I expect to soon be in the black," he says. He holds spread bets that are long on the gold price, and long on Unilever, the Anglo-Dutch soaps and fats giant. He also bets on foreign currencies.

Mr Ramsden details his experiences on his website www.solutionseeker.net, which is aimed at novice investors.

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