The Pros and Cons of Spread Trading

Let’s look at the advantages and disadvantages of spread betting:

Advantages of Spread betting

  • Zero Stamp duty – Unlike buying a normal share from a broker, you will be exempt from paying any form of stamp duty on your trades. Stamp duty is a fee charged for every stock purchased through a brokerage firm, it is currently at 0.5%.
  • Ability to short shares – Money can also be made by betting against the value of underlying stocks if the movement is correctly predicted. This is very easy to do across a wide financial instrument and using spread betting makes it even more so.
  • Guaranteed Stop Losses: Spread betting is risky and you can easily be swept away in the tide of the financial market if no care is taken to protect your earnings. The best way to reduce this risk is with a guaranteed stop loss, which limits how much one can lose when the market moves against you.
  • After hours trading: Another benefit of spread betting trading is the ability to place a trade even when the market is closed. Investors who work full time jobs, and invest after work, benefit the most from this feature.
  • Minimum Margin requirement: The majority of Spread Bets are made on margin, which means that you are only providing part of the money that you are making the bet with. Therefore, you can make £1000 worth of Spread Bets, even if you only have £100 to bet.

Disadvantages of Spread betting

  • High Risks: When trading on a margin, the potential for risk is much more than the investment that the trader is putting forward. Given that most brokers only require 10% of the bet, there is still a possibility that you could loose 5 to 10 times you invested on the bet. Should you however go short on an investment, the potential risk in this case would be unlimited.

Looking at the pros and cons in more detail:

Pros / Benefits of Spread Trading

  • As we’ve been discussing, its simplicity is one of the great advantages of spread trading, as opposed to other forms of trading such as Options, Futures and CFDs (Contracts for Difference).
  • You are able to make money in markets going up (bull) and down (bear). We’ll show you how. Today’s markets provide an exceptional opportunity to make money on both directions.
  • When spread trading, you don’t have to pay the full cost of the trade up-front. Instead, you pay a small percentage, usually around 10%* of the total price. This is called Margin Trading which we will cover later in this guide. Using your financial knowledge to go long or short in rising and falling markets, you really can magnify returns, although the same applies to losses.
  • The money you make from spread trading is tax-free in the UK. They are exempt from the Capital Gains Tax**.
  • As you are not holding an actual share, you don’t have to pay income tax on its dividends. Instead, the value of the stock’s dividend is already factored into the spread.
  • With spread trading, you don’t have to pay any commissions. All the costs of your trade are already factored into the ‘bid-offer’ spread of the trade.
  • There are also tax advantages. Also, for those in the UK, there is no stamp duty! Again, you’re not trading an actual stock, but rather a contract between yourself and the spread trading company you are using simply on the share’s price direction. Since there’s no exchange of shares, there’s no stamp duty. The current stamp duty when buying shares is currently 0.5%. That may not seem like a lot. But let’s say you are trading £2,500 worth of stock. The stamp duty you have to pay the Government is £12.50. But if you make a couple of trades every week, that’s £1,300 a year, and more if you’re trading higher quantities. It adds up, but not with spread trading, because you simply pay no stamp duty.
  • With spread trading, you can eliminate the middleman broker and execute your trades online instantly. The trades you place go straight from you to the spread trading company you are using, instead of having to use the frantic trader on the floor of the New York Stock Exchange or in the mayhem of the London International Financial Futures Exchange’s pit. The internet enables you to trade what they are trading, without having to use them.
  • With internet trading, you can make spread trades, instantly, twenty-four hours a day, instead of being limited to normal trading hours, which for most UK markets ends at 4:30 pm.
  • Easy to use and presented in a clear manner, online spread trading platforms are often much more advanced, innovative, and useful than normal stock trading sites. Many sites also allow you to trade virtually with a ‘Demo’ or ‘Dummy’ account. This allows you to practice trading without actually risking any of your own money, but being able to see all the consequences of the trade as if you actually made it. This is a great way to learn and gain experience before using your own money.
  • With spread trading, the amount of money you can make is limitless, but there are tools you can use to limit your losses, through stop-losses, which will be explained thoroughly in a later section.
  • You can make all different types of spread trades – on equities, indices, commodities, or shares – all under one single account with a spread trading company, with much less paper work than you usually deal with in traditional trading.
  • Spread trading is a good compliment to the rest of the traditional investments you own, as it can offset losses from down stock or bond markets.

* Each share’s margin requirement is assessed on an individual basis and is subject to change
** Tax laws can change and may differ for jurisdictions outside UK

Cons / Downsides

There are some downsides to spread trading too, and you have to be aware of them -:

  • While you can gain much more than the initial money you put up for a spread trade, you can also lose more than the amount you placed. Using stop-losses, though,
    limits this problem, but one must always be wary when trading on margin, which can magnify both potential profits and losses.
  • With spread trading you can make a lot of money quickly, however spread trading is not practical for long-term investment trades as there are charges involved in rolling over trades, which, although relatively small, would mount up over a long period of time. Instead, spread trading can be seen as a compliment to your traditional long-term investments such as blue-chip stocks and commodities such as gold.
  • Just as you don’t have to pay Capital Gains Tax on any profits, you can’t use any losses you may incur to offset the taxes on Capital Gains you have to pay from profits on your traditional investments.
  • No voting Rights: As you know, you are allowed to cast your vote if you hold certain amount of shares in an organization. Although spread betting mirrors the value of the underlying assets, they do not do the same for the shares.
  • You do not receive any dividend on stocks, as you are not actually holding them. But most stocks don’t pay substantial dividends, and in any case, a stock’s dividend is already factored into the trade’s bid-offer spread, from which you benefit.
  • In traditional investing of regular stocks and shares, you only incur losses when you decide to sell your shares, but with spread trading, if your trade goes against you, you are faced with that loss as soon as you have closed the trade.

With spread trading, the amount of money you can make is limitless, but there are tools you can use to limit your losses, through stop-losses, which will be explained.

In summary, the internet has opened up the exciting world of spread trading to the average individual investor, who needs little money to start making big trades. The Pros of spread trading do outweigh the cons, but risk is involved, and just as potential profits are limitless, unless you use the right tools, your losses can be great as well. While spread trading is the easiest derivative to trade, you must know what you are doing. This guide will teach you the essentials.