Speculate to accumulate with spreadbetting

It's surprising how many investors have yet to discover the two big advantages of spreadbetting: first, that it is completely free of additional costs such as stamp duty, capital gains tax and broker commission and, second, that you bet on a margin and only have to put down a few % of the bet's notional value.

Spreadbetting has come into its own in 2009. Bets are made on the basis of a wager for every point the market moves, so markets that fluctuate wildly offer more potential for making (and losing) money - and for making it in super-quick time.

This has tended to polarise investors into those who are speculating on short-term movements in the most volatile assets such as gold and currencies, and those who are spreadbetting to hedge their risks, perhaps by betting that a stock market index will fall so as to protect a portfolio of equities.

"Trading habits have evolved in the last year or so, as markets have become more volatile and short term," says Angus Campbell, head of sales at Capital Spreads, a spreadbetting firm. "The average length of time positions are left open has decreased, as assets are moving in ranges that are greater than they were in the bull run.

For some investors, the day-trading mentality has returned and they are holding their positions for shorter time frames, which can be just seconds."
He adds: "Whereas a few years ago you had to be patient to achieve the desired outcome, you may now get there within a day. Trading numbers have increased, as volatility allows people to decrease the size of their stakes to make the same impact."

Even the smallest investor can make tidy profits by spreadbetting as positions are geared, which means gains or losses are amplified so even tiny movements can produce a good return. The investor puts down a low deposit (or margin) - for example, around 3% for a position on the FTSE 100.
One recent trend has been a switch away from positions in individual equities and into indices such as the Footsie and Dow Jones Industrials 30, as investors believe they can predict the general direction of the markets more easily than they can predict the future of single shares.

The level of market volatility also makes it easier to achieve worthwhile gains from short-term index trading even where the bets are relatively modest.

"Current popular strategies among our traders include those who are following a contrarian strategy," says Davin McAnaney, commercial manager at paddypowertrader, a spreadbetting website. "The investor basically sees a range that a stock is trading in.

When it gets near the top of the range, the investor goes short [sells] and when it reaches the bottom the investor goes the opposite way, attempting to make small gains through a series of trades."

Other clients are following a sector strategy and picking specialised stocks. "An example would be the mining sector," says McAnaney. "The movement of commodities upwards, as a lot of investors move into gold, has benefited the industry."

Spreadbetting also allows investors to go short - to bet that an asset or market will fall. The big trend, according to Philip Gillette, sales trader at spreadbetting site IG Index, is towards increased hedging activity, which involves going short.

A popular strategy is for investors to bet against the market to protect gains made in an equity portfolio that they cannot close without incurring capital gains tax. "It's not a perfect hedge, but it protects the downside," says Gillette.
More than ever, short-term volatility in currency markets enables money to be made quickly if you make a good call. For example, in January 2009 the euro/£ rate was at 0.9500 and you could have sold at £1 per point if you expected the euro to weaken against the sterling.

By mid-February it was 0.8800, when you could have closed your position for a profit of £700 (0.9500 - 0.8800 = 700 points x £1). Conversely, in early August the euro stood at 0.8549 and by late September it had risen to 0.9207. Had you bought that trade at £1 a point your profit would have been £658.

Access to commodities

Spreadbetting is often used to access assets such as commodities, and here the fact that it strips out the unwanted currency effect is useful. Take gold, which is dollar denominated and has been particularly popular recently as a perceived safe haven, but where currency presents a complication for traders who aren't denominated in US dollars.

Buying gold on 2 September 2009 would have seen you pay $950/oz. Holding this until 17 September and selling at the highs of $1,023/oz would have seen you make a profit of $63/oz, says James Hughes, market analyst at CMC Markets.
Making the transaction in sterling, however, would see you actually make much less of a profit. As gold increased so did sterling's value against the dollar.

On 2 September, £1 was worth $1.61 so gold was £590/oz. By 17 September the pound was worth $1.66 meaning gold was only worth £616/oz. So instead of making 6.6% through the US dollar you only made 3.7% in sterling.

However, because spreadbets are traded in pounds per point for every "point" the underlying instrument moves, regardless of the currency, you make or lose a pound. By using a spreadbet on the above scenario, the trader would have made that 6.6% profit.

A drawback of volatile markets is that investors with stop losses or limit orders can get stopped out of the market during periods of extreme volatility. A limit order is useful if you want to make a set amount of cash, but you might choose to close out only a portion of your trade when you've made enough and leave the remainder invested.

You can put in place a trailing stop to protect your profits, which moves the stop a set number of points behind the market as the trade moves in your favour.

Most investors set up accounts with two or more firms, so they can check they are getting a good spread on a deal and ensure they can access the markets in difficult times. Many investors trade on several accounts simultaneously, leveraging the maximum their assets allow.

Spreadbetting firms are competitive and have improved their terms. Some, such as IG Index, offer spreads on tiny companies with a market capitalisation of just £10 million, but other firms do not offer prices on stocks with market caps of less than £50 million or £100 million.
However, the smaller the company the less liquid the shares, so you may have to put up a margin percentage of 25% to 50% for such stocks.

Firms such as Capital Spreads try to maintain tight spreads across markets, for example, one point on the Footsie and Dax between 8am and 9am (thereafter five and six points respectively), and two "pips" (for example 0.9205-0.9207) on the euro/£ rate.

This article was originally published in Money Observer - Moneywise's sister publication - in November 2009