Despite the astronomical rise in popularity spread betting has seen over the last years, many traders are still quick to criticise this potentially lucrative method of trading, and there are a number of common myths floated by individuals who haven’t yet experienced spread betting, or who don’t understand the intricacies of the format.
Fortunately, the majority of these rumours are just that, and have no basis in fact whatsoever. Even large institutional investors like pension funds and insurance companies invest heavily in spread betting positions. Here’s our quick debunking of a few all-too-common myths you’ll no doubt hear about spread betting.
Myth #1 – Spread betting is too complicated for the average trader
This myth is one that, for the uninitiated, might seem quite plausible. After all, looking at a list of spreads might seem like quite a complicated visual, and one that is difficult for beginners to get their head around. In actual fact, spread betting is considerably easier than many alternative forms of investing, and within about 10 minutes, it’s straightforward enough for even a total beginner to understand how spread betting works and how you can make money.
You can get started spread betting with as little as a spread betting account and an initial deposit. Simply by choosing a broker and depositing your capital, you can access the markets virtually instantly (after your ID is verified and any credit checks are complete) – there are very few barriers to entry when it comes to the act of spread trading. However, that’s not to say you will be successful, and you are strongly advised to spend a few full days, weeks or perhaps even months getting to grips with what spread betting is, how it works and the behaviour of the markets. Spread betting takes no prisoners, and it makes no excuses for trader ignorance – success depends to a massive extent on being competent and capable of executing logically sound trades as part of a sensible, sufficiently cautious trading strategy.
Myth #2 – Spread betting requires a level of capital beyond the reach of the new investor
This is simply not the case. Many spread betters start off placing tiny stake amounts, and it would be feasible to start spread betting with an account less than £100 in value. Of course, the more capital you have to play with, the more likely it is you’ll make a decent return, but you are by no means limited to investing hefty amounts to access the markets. As a result, many traders who are priced out of the traditional securities and derivatives markets turn to spread betting as a lower barrier to entry alternative.
Myth #3 – Like other forms of gambling, the odds are always in favour of the house
Firstly, spread betting is only technically gambling and is much more akin to trading than it is to betting. While it is true that the broker always builds in a commission component (known as the ‘spread’), it is not the case that the odds are stacked against you as with actual gambling. In fact, the odds in spread betting play very little role, in that it is the behaviour of the market that dictates whether or not, and by how much, you are successful.
Spread betting companies make their money primarily from the spread portion on each transaction – i.e. the difference between the buy and sell price of a market. Spread betting is commission free, so there is no percentage charge incurred on each transaction – the sole way in which they generate revenue from each trade is via the spread, which is often as slim as one PIP.
For example, if the broker is quoting 6000-6001 on the FTSE100, the one point difference represents their commission, and will widen or narrow depending on the liquidity of the market – thus, FTSE shares will come with narrower spreads than AIM shares, and will cost less to trade as a result.
While it is a common misconception that spread betting brokers will their clients to lose, much in the same way as a bookmaker, this is not in fact the case. The broker’s exposure is hedged on the futures market to cancel out (and possibly even profit) from open trading positions. Remember that it is the spread that brokers profit from, so the more transactions, the merrier, as far as they (and their shareholders) are concerned.
Myth #4 – Brokers cheat their clients by giving inaccurate market data
Often the cry of frustrated traders still smarting from their losses, the implication that brokers deliberate cheat their clients is one that must be refuted. The rogue element of regulated brokers is minimal, and brokers trade off the back of real market data rather than trying to cheat their way to profitability. After all, brokers make enough money as it is, and want your repeat business, rather than being the short-sighted scoundrels some traders suggest. This myth emanates from traders who feel frustrated that despite their best efforts they continue to lose more often than they win, but unfortunately that’s simply down to the complexities of the markets rather than any underhanded broker conspiracy.
Myth # 5 – Spread betting is dangerous
This one probably stems from traders who’ve found it difficult to master spread betting and who have failed to see any great reward for their efforts. Spread betting is only financially dangerous if you’re trading blind – that is, essentially, if you don’t have a clue what you’re doing. Anyone who wants to make an impact as a spread traders needs to know how the system works, how the markets operate, and what risks they are taking on board. Spread betting can be dangerous if you take unnecessary risks, but there are mechanisms in place to prevent you from losing vast sums of money, particularly stop losses, which are designed to present the runaway risks that are often paint spread betting in a negative light.
Spread betting is inherently risky, given the nature of the transaction. When a spread betting position moves up by 10 points, the return is 10 times the stake. When a position moves down by 10 points however, the loss is still 10 times the stake – that’s 10 times more than was invested up front. And with financial markets, there’s virtually no limit to the number of points a position can win or lose, which could land you in serious financial trouble.
Fortunately, there are ways in which you can counteract the risks of spread betting. Firstly, you need to be aware of the potential risks you’re facing, and you should always work out the numbers before making a particular trade. You might feel comfortable at £1 a point, until you realise that you could rack up a massive debt over a trading hour. Don’t get greedy, and remember that you can win and lose in equal measure.
It is also possible to position stops with the broker which prevent your liability from running away into problem territory. By setting stops below the level of comfortable risk for each transaction, you can automatically cut out your losses before they become too significant.