David Jones, Shares: Spread betting has gained a high profile over the last few years, but for those who are not familiar with it what is a spread bet and how does it work?
Charles Runham, Spreadex: A spread bet is a tax-efficient wrapper around a price. It can be applied to a number of products - shares, indices, commodities, currencies - you name it.
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Jones: It's virtually the same as trading the underlying index or the shares - I buy if I want it to go up, I sell if I want it to go down. Is that how it works?
Gerry Lannen, Goldline: Yes. It's an easy way to participate in the markets, especially for those who aren't particularly financially sophisticated. The tax benefit is an enormous benefit, plus the fact that it's all instant - you can be in and out of the markets and see exactly the positions you're holding on a minute-by-minute basis.
Jones: So if I make, say, £150,000, over the next year spread betting, I don't have to give any of that to the tax man?
David Morrison, MF Global Spreads: None at all. You are not paying any stamp duty and you are not subject to capital gains tax on any of your profits. Two other things about spread bets. A bet always settles to some underlying instrument so as a customer you know that if you don't close out the bet before the end of its life it will ultimately settle to something at a specified time. Spread betting also makes it very easy to go short of individual shares, which hasn't always been possible in the past. People have been able to do that more and more because of CFDs being more widely available, but spread betting is a very simple way of getting involved and going short is as easy as going long.
Gerry Lannen, Goldline: Jones: What markets can I trade in?
Simon Denham, Capital Spreads: You name a financial market and a spread betting company will probably make a market in it. We quote in most US, UK and European shares, and in commodities from lean hogs to oil to gold.
Just as CFDs are effectively a never-ending bet, we offer rolling spread bets too. They have no expiry date - you just get charged an interest rate on the underlying value of the product each day, or, if you are short, we will even pay you to hold the position.
Jones: Say I'm looking at the FTSE100 on a website and at the FTSE100 Cash Index with a spread-betting firm. Where do the spread-betting prices come from?
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"Every spread betting company ought to be able to justify the
price it's made and the price it has stopped someone out on."
Charles Runham, Spreadex: From the futures market and from expectations of where the cash will end the day in relation to the futures.
Jones: People may not be sure what they're trading on. They see the FTSE100 Index or the Dow Index and they look at the spread-bet price and think - hang on, the spread better has already marked the price up. But of course, the spread betting prices will be based on the futures and the futures will be leading the market. The index takes a while to catch up with where the futures are going, so if you have some sudden news you may not see that reflected straight away in the underlying cash market.
Lannen: Quite often we get people saying, 'we believe they run out stops to stop us out and the price they're making isn't actually a mechanical price, it's their own price that they're quoting'. That's a real concern of some people.
Jones: So let's say the company has 100 clients and 99 are long Vodafone and one client short. The implication is that they will skew the price down to pick out the stops of those that are long.
David Morrison, MF Global Spreads: Every spread betting company ought to be able to justify the price it's made and the price it has stopped someone out on. I don't think anyone round this table would dispute that. If someone does feel that they have been unfairly stopped out, then they should straight away ask us to justify why they were stopped out at that particular level.
As to the actual mechanics, it is fairly straightforward for us to show how a forward price is created with our spread around it. The futures are very much the tail that wags the dog. The other thing is that there are certain markets we quote out of hours, and I am thinking specifically of the FTSE market. We are quoting that from seven in the morning until 9.45 at night. We have to be able to justify our quotes out of hours but in fairness if the US equity markets are moving in a dramatic fashion that is going to affect our FTSE quote.
Jones: People should bear that in mind that if they are going to trade out of hours, you are providing the service as a spread better but they have to take on board a level of risk. Basically you're making the price up based on what the US markets are doing.
David Morrison, MF Global Spreads: Indeed. They can choose to leave their stops in one of two ways. They could do it basis our quote or basis the screen price. If it's basis the screen price, that stop can only be triggered when the underlying market is open.
Jones: So if the Dow drops 800 points when London is shut, your out-of-hours FTSE quote is going to drop to mirror that. But if I haven't chosen to have my stop in out of hours, then I won't get stopped out until the next morning, depending on what happens when London opens.
Charles Runham, Spreadex: Some people also get confused by the future price and the actual price. It's easier to track the actual price that a stop traded at.
Simon Denham, Capital Spreads: Equities do have this problem. Virtually every other market has a real underlying product you can base your quote on but a six month forward GlaxoSmithKline price can be 20 points away from where the current price is. It's entirely our quote - one which we, and our competitors, derive from various market tools.
Forward equity prices will depend on things like the six months' Libor rates and what the expected dividends are. That is where you get some confusion. It is a much more difficult concept to understand than the share prices you see every morning.
Jones: People should realise it is a two-way market and for every buyer there is a seller. If there were a spread-betting company out there manipulating the price to kick out stops, there could well somebody waiting to jump on board that price and buy it, so it cuts both ways.
Simon Denham, Capital Spreads: Capital Spreads makes it a point of policy that we never, ever, bias our prices. That is the price at that moment in time. Therefore the Fair Value of a market at the beginning of the day stays at that level on the FTSE100 or the Dow or whatever for the whole of the day.
Jones: There will always be people who love a conspiracy angle.
David Morrison, MF Global Spreads: What we can say now is that there is far greater transparency of prices. You've got so many companies making prices on the same instrument that to get wildly out just isn't sensible.
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Jones: Why would I, as a private investor who over the years has bought and sold my Vodafones, Glaxos and BPs, want to start doing spread betting on all these different markets?
Lannen: The first thing is shorting. People who buy and hold shares then watch them fall are in a losing position while those who are spread betting are winning on the other side. You can actually turn over more money, especially in choppy markets.
"People have become a bit suspicious
of organisations that manage money
and spread betting gives them the chance
to manage their own own positions,
taking their own view and benefit
or suffer their own judgement"
Jones: You don't have to be jumping in and out of Vodafone going short five times a day - you can do longer-term short positions as well, can't you?
Lannen: Yes. It also gives people more control over what they're doing. People have become a bit suspicious of organisations that manage money and spread betting gives them a chance to manage their own positions, take their own view and benefit or suffer their own judgement. There's also the visibility, the fact that you can go on-line and see exactly what your net results are, your bottom line.
Charles Runham, Spreadex: The leverage is also something to look at. On a lot of the mainstream shares Spreadex will only require 5% margin, which I believe is the lowest on offer. That can be a tremendous advantage in freeing your cash to do other things.
Jones: Can you put margin in a nutshell for me? If open a spreadbetting account with £1,000, what sort of exposure can I have with that?
David Morrison, MF Global Spreads:It varies from market to market and from company to company. But to give a straightforward example, if you were to buy 1,000 shares with your broker - share XYZ costing £2 each - then that's going to cost you £2,000 plus commission and stamp duty. If you're doing the same thing with a spread better, because you are dealing typically for a future date, we'll ask you for say a deposit of 10%. Rather than putting up £2,000, you're putting up £200. That's your initial margin requirement.
People should be aware that that's not your full liability. If you've bought, this is still the same as if you'd bought the underlying. But nevertheless, you are using less capital to trade with a spread bet. We do advise people not to trade up to their account limit but to leave some money available should the market move against them, because otherwise they could be asked to put up more funds to cover the margin call. It could be seen as risky but if people manage the positions sensibly, and we often recommend that they use stops, there's no reason why it's any more risky than dealing in the underlying shares.
Simon Denham, Capital Spreads: This is one of the areas where Capital Spreads is different from everybody else. Because we insist on stops on every position, which means we can charge less margin than everybody else. We can in effect give clients a bigger leverage. If you have a position £10 a point in the FTSE and you've got £500 in your account, we will say your stop is at 40 points away, which is a £400 point loss. The other 20% we take as a cushion just in case the market gaps. Most of our competitors will require £1,250 to £2,000 to make the same bet.
Jones: How do spread betting firms make most of their money?
Simon Denham, Capital Spreads: Where all spread betting companies hope to take money is by getting as many buyers as sellers, so we can make the spread with no risk. If not our dealers can go into the market and hopefully buy the shares at a better level. If they can't, they cover our risk and take the loss. We don't employ 17-year-olds to go into the market and do whatever they wish. We employ professional dealers to manage our risk.
If we have a very good client who makes a lot of money we might 'over hedge' him. Say he's
bought 10,000 Royal Bank of Scotland equivalent shares by making a £100 up bet, we might go in and buy 15,000 because we realise that he has done all the analysis and spent time on that particular product. We quote 1,800 products, we haven't got time to look at them all individually.
Jones: Let's say I do a £10,000 trade in Vodafone. If I'm doing it on a quarterly expiry type bet, then part of the interest rate charge for the margin is built in - there are not going to be debits from my account every day, are there? Whereas with rolling daily expiry bets, which can run and run, I expect to see a debit from my account every day for the interest rate charge.
Simon Denham, Capital Spreads: With rolling daily bets on shares if you're long you will be charged - if you're short you will see a credit to your account.
Jones: What are the common hurdles a new spread better faces?
Lannen: Spread betting is exciting and once people get started it can be a bit like having a fruit machine in their own houses. The first hurdle they can encounter is over-trading - they get carried away. The second thing is that people tend to trade with their gut feelings as opposed to the reality of what is happening and need to look at the maths behind what they're doing when they trade. If I go into a casino with a quarter of the roulette table covered in zeros, it's not a good bet.
It's important to have a system, have a plan of action which you work through and which creates the discipline. Because it's called trading, they feel justified if they lose - but they need to understand that it is betting. After all, that's why it's tax free. They have to realize that they're taking on people who are much smarter than them.
Jones: You mean the other traders in the market place?
Lannen: Yes. They need to plan their trades and trade their plan. It's our experience that the most successful people tend to have more losing trades than winning trades.
Jones: So, if every time you are wrong you lose £10 but every time you're right you make £500 you can be wrong an awful lot of the time but certainly profitable.
Charles Runham, Spreadex: Exactly. It's being disciplined and cutting a position if you are wrong.
Jones: The problem everyone has is to admit when they're wrong.
Charles Runham, Spreadex: Absolutely.
Jones: Which is why with spread betting companies, we can set our stops in place and walk away. That's the disciplined way of trading but it's easier said than done.
Simon Denham, Capital Spreads: The main problem for spread-betting clients is that they generally run their losses and not their profits. A top trader will have five winning trades and 12 losing ones, but the losing trades will all be £50, £100, £70 and the winning bets £500, £700, £1,000. If your stop loss is 50 points away, why are you taking a profit after 10? That way you've got to win five times before you make up one loss.
Jones: Another misconception that people have about spread betting is that it is just for short-term trades. You can buy and hold with spread bets the same way you can buy and hold with traditional shares.
David Morrison, MF Global Spreads: Spread betting lends itself to many different time frames.
Jones: How do you see most of your clients trading? Are they day traders, are they trading over a few days are longer term?
Simon Denham, Capital Spreads: It depends which markets they're interested in. If they're in equity market shares, they tend to be longer-term traders because the individual shares don't move that much, especially in the UK. At the moment our biggest market by far is currency - more than half our trades every day - and here people are generally very shortterm, in and out all the time. People like to trade in markets that move.
Jones: Is it necessary to have easy access to the markets all day to be able to make money spread betting?
"...if you haven't
got a map of where you're going
you lose faith in your journey
Lannen: It's probably counterproductive. One of the things we found that creates success for clients is the fact that they set the trades for five minutes of the day then go away and forget the markets.
One of the developments in the spread betting world is the facility to set contingent orders. This means you can now set your positions, entries and exits, in advance of the market, then go away and get on with your normal life. You're not sitting there reacting to your emotion.
The temptation when you're watching the markets is to preempt what might happen, get in five pips too early, then you're forever trying to dig yourself out, get yourself out of a position you didn't intend getting into in the first place.
The second thing is that it's fun and while you're waiting for your good trade to pay off you can lose five times more entertaining yourself.
David Morrison, MF Global Spreads: We have customers trading 10, 20 times a day, going in and out of the S&P non-stop and doing it successfully - and being disciplined at the same time. They are looking for something, they are looking at certain levels, not taking a long-term view, but nevertheless they have levels in mind - they've done their homework.
Jones: Can you beat the cost of the spread if you trade in the S&P 20 times a day?
David Morrison, MF Global Spreads: Yes, people do. The spread on daily S&P futures is not big.
Jones: Let's walk through the nuts and bolts of doing a spread bet. Say I want the equivalent exposure of buying 1,000 shares in Vodafone. How do I get that exposure via a spread bet?
Simon Denham, Capital Spreads: With spread betting a £10 bet has the same market exposure as buying (or selling) 1,000 shares (for UK shares). If you want to buy 1,000 UK shares you make a £10 bet, if you want to sell, you sell a £10 bet. Our minimum margin on Vodafone is 5%, so to make a £10 bet you're going to have to have at least £50 in your account. If you just have this minimum in your account, our computers will then set a stop four points away. So with Vodafone at 140p a share, for £50 you have the same Profit/Loss profile as buying the 1,000 shares costing you £1,400.
Jones: And if I want to have a wider stop I need to make sure there's more money in my account.
Simon Denham, Capital Spreads: Yes - exactly.
Jones: When it comes to weighing up the risk, you don't want to be betting the same amount on every instrument - £10 a point on Vodafone at 140 means you've got £1,400 of exposure but if you do £10 a point bet on the Dow at say 10,700, you've got more than £107,000 exposure.
You need to think about how much risk you want in relation to where your stop is going to go and size your bet accordingly.
David Morrison, MF Global Spreads: Talking about pounds per point, it's important to point out that if you are dealing in currencies with spread betters you can deal in £1 or £2 or £10 per tick and so make or take payment in sterling. If you were doing that on the Forex market or with a broker, you have to make or take payment in the underlying currency.
Jones: A fair point - you don't have the currency risk.
Charles Runham, Spreadex: It is a problem if people try to think in dollars - we keep having to explain to them that they have taken the bet in sterling.
Jones: Do people get confused by the pounds per point business when they have been used to buying shares?
Lannen: Yes, but what we've done at Goldline is to streamline the breakdowns into a very simple process. Usually one of our clients will put aside a sum of money as their risk capital. We then trade, say, the indices - our programme will look at the optimum entry and exit points, so for the Dow the stop might be 100 points and for the Dax it might be 25 points. Money management is key. The programme takes an amount of their client's capital - say 5%, which is fairly aggressive - and divides it by the number of points we are going to risk on a trade. So, for example, with the Dow it might be 5% of the capital divided by 100 points. That's how much per point it will trade.
Jones: So if you have £10,000 to trade with and have allocated £500 risk to a trade, the stop is 100 points away which means you will do a fiver a point?
Lannen: That's exactly right. The trade on the Dax might then be £20 a point, so they have a balanced risk across the indices they trade in and the risk is always limited, not just to movement in the market but the amount of their capital.
Jones: This should be an approach that people follow for every spread bet they do really, isn't it? To weigh up their risk from the beginning and size their bets accordingly, rather than simply doing £10 or £20 a point on everything.
Lannen: Yes, if you haven't got a map of where you're going you lose faith in your journey.
Jones: A lot of people offer on-line trading as well as trading over the phone. Is there any difference?
David Morrison, MF Global Spreads: None at all. The online systems make pricing transparent and there's so much functionality on there in terms of what you can do including monitoring your account in real time. But we always have someone at the other end of the phone in case something goes wrong.
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"Unless you're going to buy and
hold something for months or years,
it seems silly to do that through a
stockbroker - paying stamp duty,
no margin - when you could do
exactly the same sort of trade on
spread betting
Jones: How do spread betters make money? There is a conspiracy theory that companies only make money by clients losing money.
Simon Denham, Capital Spreads: It's not in our interests for clients to lose money because if they do they stop trading. Of course, we do like an opportunity to hedge their positions at an advantageous price but every bookie in the world lays off extra risk. We have clients who trade in far greater size in currencies than we could ever tolerate as a risk, so we go out and hedge. It makes my board very happy when our hedge book makes lots of money.
We quote very tight prices. If we have a client who trades everything in big size and it moves in his favour immediately, giving us no chance to get a hedge on, we're going to struggle. But in normal circumstances if he's a good trader then we'll follow him and following him in a bigger size than he's traded with us. Following the good traders makes us more money than the losers would - especially in the quiet markets nowadays.
Charles Runham, Spreadex: Let's be honest, we're in the business to make money. We're not a charity but we facilitate the business. If we can make our little cut in facilitating the client into the market then we're very happy to do it.
Jones: A lot of business must be self-hedging. Say you have 100 clients and 50 of them think Vodafone is going up and 50 trade the other way. That's perfect, isn't it?
Charles Runham, Spreadex: Every firm will have its own book value where if somebody is coming on and doing £5 of Vodafone it's not cost-effective to go hedge it. But once you've built up to a certain value you will go into the market and hedge. Professional traders are paid to take calculated decisions and risk on behalf of the company.
Jones: It's easy to get bogged down in how the spread betting company makes money. All I as a customer want is sensible spreads and the ability to trade. What facilities do spread betters offer to make my life easier so I don't have to sit there and watch a screen all day?
Charles Runham, Spreadex: We will take orders from you to open and close trades as well as guaranteed stops in major stocks and indices.
Jones: Okay, so just walk me through that. I want to buy the FTSE if it dips to 4900 and it's currently 4960. What's that order called?
Charles Runham, Spreadex: Opening order or limit order - different people call it different things.
Jones: But I would say I want to place a limit order to buy 4900?
Charles Runham, Spreadex: Yes. Then we would ask you whether you wanted to buy that in cash or in future. That's also where a lot of people get confused and say, 'I see it hit this' when it didn't hit that in future, so we try and make absolutely sure we are looking at the same thing.
Jones: Then I just walk away and leave it?
Charles Runham, Spreadex: Absolutely.
Jones: Let's say I'm long on the FTSE but I want to get out if it falls to 4850.
Charles Runham, Spreadex: Put a stop loss in. You can have an order to lock in your profit and to cut your losses.
Jones: How does a guaranteed stop loss work? Let's say I bought Vodafone at 140 but it came out with a profit warning and the next trade went to 105, If I had a guaranteed stop loss in at 130, what would happen?
David Morrison, MF Global Spreads: You can either request a guaranteed stop when you open a bet, or you can put one on at any time after you've opened that trade. There is an extra charge for a guaranteed stop - for any FTSE100 and many FTSE 250 shares we charge 0.5%.
Once that stop is in place, it doesn't matter what happens to the price of Vodafone - your bet would be closed out at £1.30, so the maximum risk you have is your opening value less the guaranteed stop level times the size of your bet.
Simon Denham, Capital Spreads: We don't offer a guaranteed stop loss, partly because think the spread betting industry makes a fortune out of guaranteed stops that are hardly ever activated outside of being an ordinary stop. Also, you can't put it closer than 5% on UK stocks and on US stocks most of the companies won't allow you to place it any closer than 10%. You've got to have a pretty massive profit warning to move the market down 10% outside of trading hours. Everybody talks about 9/11 and 1987 but a simple piece of mathematics shows that continually paying away the guaranteed stop premium on every trade would soon negate even the worst fall in the history of the modern markets.
David Morrison, MF Global Spreads: I have to disagree because I think the guaranteed stops, especially on stock indices, are exceptionally good value for money. Catastrophes don't happen that often but they do - I was around for the 1987 crash and we were all around for the 2001. We had plenty of people who benefited from having guaranteed stops on both those occasions.
Jones: It's down to the individual to decide whether it's a premium they are happy to pay..
Jones: Let's say I'm at the stage where this spread-betting game sounds fantastic and I want to open an account. What do I need to do? Do I need to prove I'm massively experienced, because I'm not. Like a lot of people who might have been active in the stock market, derivatives are a new thing to me. What sort of things do you look for when people want to open an account?
Charles Runham, Spreadex: We try and make sure that when somebody does open an account, before they actually trade they understand the concepts. Actually opening an account is much easier nowadays - we're all FSAregistered and there are various application procedures which have to be adhered to. Then our customers will be given a credit rating and it is down to them to ask for a credit limit if they wish.
Simon Denham, Capital Spreads: At Capital Spreads, we don't offer credit as we believe that if we give people the ability to trade on highly-leveraged positions we shouldn't also be giving them credit to do so - effectively we allow people to gear up as much as 30 times on shares, and 200 times on foreign exchange. Having no credit facility is one of the reasons we can offer tighter spreads than most of our competitors.
David Morrison, MF Global Spreads: You can also apply for and open an account on-line. When you do that you can get your account open with us within 20 minutes, but there are checks we make - for proof of the address, for a criminal record and for credit worthiness, and obviously the check to make sure people are over 18.
Once we've got those details on-line we will open up a temporary account until we receive the completed application form, which we ask you to print off, sign and send back to us. A temporary account limits the types of bets and the length of the bet you can do until we've got that signed form back - we view this as a sensible cooling-off period for new customers.
Simon Denham, Capital Spreads: We also have on-line account opening but once the account is opened we don't limit clients to particular markets.
Jones: Starting small is a sensible way of doing it: what's the smallest-sized bet I can do?
Charles Runham, Spreadex: If it's indices, £4 a point on a daily cash bet. If it's individual shares, it depends on the share price.
Simon Denham, Capital Spreads: Every single market is the same with us and the smallest you can trade is $1 a point. You can have a dollar, euro or sterling account, but if you have a sterling account the minimum size is £1.
On our platform, our pride and joy is our demo site which is an exact copy of the live trading platform. If a client is unsure how it all works or whether he has the ability to make money doing it, he can do a bit of a practice first. We'll give him £10,000 of electronic money and he can trade in a good selection of the markets that are on the live platform. It has all the order functionality, including the stops.
Charles Runham, Spreadex: At Spreadex, you can view your account, balance and trade positions on-line but you can't trade electronically. There are some fantastic electronic trading platforms out there so why try and offer another one? We've tried to concentrate on a more personal bespoke service by talking to our clients and trying to help them get what they want and make sure they know what they're doing.
David Morrison, MF Global Spreads: We have an association with a company called Insight, who teach people not just the basics but an awful lot to do with trading - technical analysis, charting, looking at individual stocks and other markets, the psychology of being a trader - all kinds of useful stuff for someone starting out. We believe it's a very useful course for someone who is new to trading or spread betting.
Jones: Taking into account everything we've discussed today, do you think it is going to mean a continual decline of business for traditional stock brokers?
Lannen: Yes. I've got no need for a stockbroker, bottom line.
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Jones: Unless you're going to buy and hold something for months or years, it seems silly to do that through a stockbroker - paying stamp duty, no margin - when you could do exactly the same sort of trade on spread betting. But do you think there's room for another load of spread betting companies or do you think we're going to see some changes within the industry?
Lannen: From the clients' perspective, the change over the last couple of years has been quite good. It's very easy for people inside the industry to forget what a daunting experience it can be for a first-time trader. But I think the spread-betting world is getting more customer-focused now.
Jones: And people have a lot more choice than they did 10 years ago.
Lannen: A lot more choice, and the ability to create orders on-line means they can be more confident about the orders they are placing.
Jones: To sum up, why should our readers consider using your companies for spread betting?
Simon Denham, Capital Spreads: Capital Spreads has a fully online trading platform. It has exceptionally tight prices, the spreads are very competitive - we try to ensure that our prices are either better or the same as every single other spread betting company - and we pride ourselves on that fact. We have a wonderful customer services team who are forever being praised by users. We have a complete demo platform so that our clients can test out their capabilities, a beginners' guide and educational tools on-line.
Our charting package has far more technical analysis tools than I've ever used, and I've been a trader for more years than I care to mention. With our risk-monitoring systems we also try to take care that our clients don't over-expose themselves in the markets.
David Morrison, MF Global Spreads: At MF Global Spreads we have taken the best elements of all the different companies and pushed everything up a notch. We have a very high level of telephone service - and the functionality of our internet service and the speed and reliability of the platform are really second to none.
Every new product that comes out takes it to a higher level. We are a division of a FTSE100 company and I think that raises the profile of the industry as a whole, giving confidence to customers who are coming to spread betting for the first time.
Charles Runham, Spreadex: Spreadex has been going since 2000. We offer some of the lowest notionals around and we pride ourselves on the more personal service. We're not trying to compete with the online services, so we try and cater to our clients' more individual needs and have developed a niche in that way.
Brought to you in association with MoneyAm Shares Magazine
