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Taking the gamble out of spread betting

One of the fastest-growing areas of investment in the UK is spread betting, with some estimates putting total annual industry sales at £150m and rising.

Compared with the billions of pounds being pumped into collective investment schemes each year, this represents a tiny drop in a very deep ocean.

But those making the investments are not all City slickers – many are ordinary people using the internet to play the markets themselves without advice or a fund manager to run their money.

The principal advantage of spread betting – where gambles can be made on the future level of share prices, indices, bonds, commodities and currencies – is that investors can go either short or long.

This means that they have equal chance of making money whether the markets are falling or rising, unlike a great many investment funds which simply track an index.

As spread betting is literally a bet, all profits are exempt from capital gains tax and there is no stamp duty or, in some cases, brokerage fees. Most dealing can also be conducted online with instant execution so there is no investment lag – there cannot afford to be when most bets concern whether an index will have fallen or risen over the course of one day.

IG Index, the biggest spread-betting firm in the UK, says this accessibility is a huge boon for daily traders but warns that, without some degree of knowledge, investors are liable to fall flat on their face.

Head of financial dealing Giles Wilkes says: “We expect people to be reasonably financially astute. They need to be able to do maths in their head, especially with shorting, which requires rapid decision making. Most of our customers would represent a typical cross-section of people with some financial knowledge.”

One of the areas that investors can struggle to grasp is leveraging. This is where companies offer contracts – basically derivatives – in which investors buy the price of underlying shares or indices rather than the assets themselves. This means that investors can buy a contract – enabling them to control a certain amount of money over a set period – worth up to 10 times more than they have in their account.

For instance, if an ordinary investor wanted to buy 300 Barclays shares at £4 each, he or she would have to stump up £1,200. But a spread better would only have to have, say, £120 to buy the same number of shares as the company is effectively lending them the difference and charging interest. Profits are calculated as if £1,200 has been invested but losses are magnified in the same way which is why the FSA demands that investors have experience before opening contracts.

It is for reasons such as these that most companies warn against people using their pensions to finance spread bets. In fact, so short term are they that most investors close their bets on shares within a fortnight while those speculating on indices shut theirs within one day. After six months, even longer-term bets become uneconomic to hold any longer. But most investors are not looking for long-term profits anyway, with many only involving themselves in the markets at irregular intervals.

City Index, one of the higher-profile spread-betting firms, says only about half of its 10,000 clients are what it describes as active traders who habitually play the markets. The rest tend to pick and choose which times to invest, suggesting that a great many are not committed gamblers but housewives, mechanics and other people with ordinary jobs.

Although on paper they may fit the typical Isa customer demographic, these people are not the average Isa holder – they are far more sophisticated and proactive than that.

According to City Index, however, that does not mean traditional investors should ignore spread betting altogether.

Chief market strategist Tom Hougaard says: “If they think bad times are ahead, investors can protect their portfolios by shorting some shares or even the index to which some of their investments are linked. At the very least, they can stand still, returns-wise, or even make money. There can be synergies between the two.”

Nevertheless, Hougaard admits that most customers are outright spread betters simply looking to turn quick profits. The problem is that most traditional investors are unable to make investment calls themselves and those that can on their behalf are not necessarily keen to do so.

Stockbrokers, the obvious candidates, generally identify stocks they believe will perform over the medium term and are reluctant to take bets on a daily basis, especially when the potential losses are prohibitive.

David Aaron Partnership senior consultant Jason Bevan says: “Spread betting is a very effective and cheap way of investing in the stockmarket but you need access to up to date information, otherwise you can quickly slide out of control. Even for stockbrokers, it is too risky. They have got the same problems as everyone else. But I have got clients who do it. It is quite surprising how widespread it is.”

Part of the appeal is the variety of bets that can be made. Not only can investors take a leveraged position on most major indices – called a binary bet – they can also gamble on future house prices and any number of other “special” markets.

But, with all of them, the problem remains the same – without sound knowledge of the subject of the bet, investors are likely to lose. The way spread betting firms have developed means it is easier and cheaper than ever before for investors to gamble on the markets but, as a wise man once said, you never see a bookie riding a bike.

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