In this article, we will look at the essential differences between financial spread betting and traditional shares trading. There have been some major shifts in the trading environment in the last 15 years (after the advent of the electronic order book). When placing trades with traditional there are some disadvantages that are seen (relative to the placement of spread bets) and here we will explain some of the advantages that spread betting can offer traders in the modern investing environment.
Historically, when dealing with traditional shares trading, investors would only have the option of buying stock shares and then selling those exact shares later at whatever prices were available. Financial spread betting, however, offers a great deal of added flexibility of buying stock shares in anticipation of an increase in the shares price levels (or, to sell when price declines are forecasted).
Financial spread betting is not subject to dealing charges or stamp duties and capital gains taxes. Because of these major differences with traditional shares trading, investment alternatives (such as spread betting) are increasing in popularity and being viewed by many as a more credible option when looking to invest your capital. The main difference here, though, is that when conducting spread betting trades, the physical shares of the underlying company are not actually owned. Because of this, spread betters have no shareholder rights and can do nothing to directly influence the managerial direction of that corporation.
Another important difference (and related to the fact that spread betters do not directly own the shares of the underlying company) relates to the payout of dividends. Dividend payments are a complicated issue when dealing with spread betting brokers, and each broker will have a different policy relative to these payouts. The trend, however, is toward an increasingly homogenous approach to these payouts and it is likely that we will soon see these differences reduced, and a more uniform approach to dividends applied. At this stage, you should ask your broker about their individual policy to see how dividends will affect your own trades.
Some brokers will pay all (or a portion) of the company’s agreed upon dividend rate, as long as the position is open at the ex-dividend date. New traders should keep in mind, however, that when initiating short positions (sell orders when price declines are expected) you may be liable to pay these dividend amounts for the duration of the trade. Be sure to ask your broker for a policy explanation relative to these payments.
Next, we will look at the key differences between traditional share trading and spread betting. Perhaps, the most basic element of spread betting trades is that your position’s profit and loss will be determined with a certain number of Dollars (or another base currency) per percentage point. Generally, prices will be divided into 1 cent per point (when dealing with a US based account), which equates to 100 points per US Dollar. So, in basic terms, this means that you could elect to buy 100 shares at $1 per point (or any other multiple) as an alternative to buying 1000 shares of the company at 1 cent per point. Price movements will create profits and losses relative to these position sizes, and larger positions will create the potential for larger gains and losses during the life of the trade.
Another factor to remember is that spread betting brokers will charge you a “spread price,” which is the difference between the sell level and buy level that is offered by your broker. These costs tend to be wider with spread betting companies, but this added cost offers some advantages that are not available with other types of investments.
Next we will look at a sample spread betting transaction using real figures. If for example, you want to buy 10,000 shares in a company with a share price of $2 per share (operating on the assumption that the stock price will rise by 10% in the coming weeks). The bid price for the stock is $2.05, while the offer price is $1.95 (which would be the entry levels for buy and sell positions, respectively). This shows a spread of 10 cents, which is what is paid to the broker for providing access to the trade.
Now, assuming the trade works as expected, prices will later move to $2.20 per share (with a bid price of $2.25 and an offer of $2.15). Exiting the trade means that, we leave at the offer price of $2.15. The total gain per share is 10 cents, and we multiply this by 10,000 (the number of shares initially purchased), to show a total gain of $1000. Spread charges tend to be cheaper for larger companies and commonly traded currencies (because of their increased liquidity levels), so trading with these instruments can help to improve on your trading costs.
Another advantage is that spread betting trades can be taken out on margin (utilizing leverage). Essentially this means that only a small capital outlay (usually 5-10%) is required when entering into the total position, and these increased trade sizes can help to magnify trading gains when prices move in a favorable direction. It should be remembered, however, that the same effect can be seen for losses, so it is very important for new traders to keep margin sizes at manageable levels. Nevertheless, this added flexibility is a clear advantage for spread betting traders and offers an attractive alternative to traditional shares investing.
All of these factors (along with improved trade execution and no liability for capital gains taxes) made spread betting a viable alternative to traditional stock investing. Recent trends are showing that many new traders are opting to start spread betting because of these advantages and most would agree that this trend is set to continue long into the foreseeable future. Spread betting brokers have different policies for different aspects of the spread betting agreement, so it is prudent to carefully read this trading agreement before real money is invested into the market.