Spread betting has revolutionised the way that UK private investors trade financial markets. Originating more than three decades ago as a niche pastime mainly of city professionals, it has enjoyed dramatic growth in recent years, drawing in people from all walks of life. This trading revolution is well placed to continue in the years ahead thanks to improving technology and financial awareness among the public.
How spread betting works
Despite its name, spread betting is very much a form of financial trading, rather than gambling. A spread bet is essentially a miniaturised version of a futures contract or a contract-for-difference (CFD). The bets on offer cover a huge range of individual shares from the UK and abroad, entire stock-market indices, government bonds, commodities, and exchange rates. A simple example will illustrate how they work.
A spread bettor wishing to speculate that the price of gold will rise could open a “buy” bet on gold at a price of $1300. Say he is willing to stake £1 per point, his total position value is therefore £1300. He profits by £1 for each $1 that gold rises above $1300 and loses £1 for each point it falls below it. With a “sell” bet, he gains as the price falls and vice versa.
The spread betting firm will typically only require a customer to deposit a small percentage of the total value of his positions in his account. For example, it would easily be possible to have positions worth £1000 with as little as a tenth of that in one’s spread betting account. Profits and losses are therefore multiplied by an equivalent amount: a 10 per cent change in the price becomes a 100 per cent gain or loss.
Although they function almost identically to investment products, spread bets are classified as wagers in British law. As such, any profits from spread betting are tax-free under present rules. This is a key attraction of spread bets, especially in today’s environment of generally rising taxes. The UK’s new government raised the rate of capital gains tax from 18 to 28 per cent in 2010, increasing the appeal of spread bets over taxable products like CFDs and futures.
Spread betting providers make money by charging clients a spread. That is to say, they charge a different price according to whether a client is buying or selling, always in the provider’s favour. They also generate income from the interest they charge on the value of their clients’ positions. In some cases, the provider will also take the opposite side of a trade, thus standing to benefit should the client lose.
Spreading far and wide
Attracted by the possibility of tax-free profits and the ability to trade with very small amounts of money, new customers have embraced spread betting in large numbers over the past few years. In 2008, researchers estimated that there were some 430,000 spread betting accounts in existence in the UK, and although the number of active traders could be as low as a quarter of that, it still represents a huge increase over the last decade, with numbers increasing by more than 25 percent a year on average.
In response to these terrific growth rates, more and more firms have entered the industry, either in their own right or via a “white label” arrangement, under which their service is run by another firm, but under a different brand.
As a result, competition among firms has intensified, much to the benefit of the spread betting public. The pricing of bets has become very keen, while interest charges have fallen. Spread betting firms’ trading platforms have improved constantly, and today freely provide customers with live price charts, research, news-feeds, and other resources that previously were only available to deep-pocketed professionals.
While the industry’s growth has slowed somewhat in the last couple of years, the prospects for further expansion are good. “The number of spread bettors in the UK should continue to grow thanks to the advantages that the product offers,” says Chris Murphy, head of retail partnerships at Tradefair, a leading spread betting provider and recently voted Spread Betting Company of the Year 2011 by readers of World Finance. “The growth is more likely to be in single digits, however. One likely source of new customers is people who are currently involved in online gaming, such as poker or sports betting.”
The financial and economic environment could well play to the industry’s advantage too. Low interest rates have reduced the appeal of holding money in savings accounts, while making it cheaper to finance spread betting positions. At the same time, volatility in financial markets has graphically taught investors the value of being able to speculate on a wide range of different assets, and that of being able to profit from market falls as well as rises.
Deeper involvement in one’s own investments is another trend that could benefit the spread betting industry. The British government is to introduce a new type of pension account from 2012, which will allow and encourage individuals to play more of a role in building their own pension. The new skills people learn in doing so could make them natural new customers for financial spread betting in time.
Spread betting’s new frontiers
While the backdrop is clearly favourable for the spread betting industry to continue its expansion, the ultimate driver of further progress lies within the industry itself. Enhancing trading technology and raising awareness of spread betting offer the most likely ways forward for the business.
The arrival of smart phones is already transforming the way the way that spread betting customers play the markets. Dealing from a mobile handset has gone from something of a gimmick to being a serious way for people to trade on the move. It is now possible to operate as a spread bettor almost as effectively from a smart phone as from a computer. Customers are not only using their phones to exit existing positions, as was predominantly the case before, but also to research and enter new positions.
“The spread betting industry has always been at the forefront of developing simpler and more effective trading platforms,” says Tradefair’s Mr Murphy. “For example, we offer a tool on our platform whereby users can automatically scan price charts for potential trading opportunities. Providers will need to continue innovating in this way in order to maintain and grow their customer base.”
With spread betting in the UK shifting from rapid to steadier growth, the structure of the industry is also set to change. “It seems likely there will be some consolidation among providers,” says Mr Murphy. “There are too many firms involved at present, and those that remain may also become more focused in their offering.”
He also believes that spread betting firms may look outside the UK to build their business. “There is a case for taking spread betting into overseas markets, even though the same tax advantages may not apply elsewhere,” he says. “Spread betting is an easy way for customers to trade, particularly those who are just starting out and who have fairly limited capital.”
Beyond spread betting
Although in one sense a rival to CFDs and futures, spread bets are ultimately of benefit to these other instruments. Spread betting is typically used as an entry-level product. If a trader has success with spread bets, he may well subsequently want or find it advantageous to graduate to CFDs or futures. While they do not offer the same tax benefits, they are easier to trade rapidly and in larger amounts, which are important considerations to more serious traders.
One of the most interesting opportunities for spread bettors as they become more sophisticated is that of Direct Market Access (DMA). DMA is a way of trading CFDs directly in the marketplace, instead of having to go through a middle man. Rather than having to accept whatever prices a provider offers them, DMA traders specify the prices at which they wish to trade directly to other traders. Orders are matched directly with one another, eliminating the delays that can occur when dealing via a middleman.
Previously the preserve of a select few, DMA trading is now opening up to a much wider audience. The critical development in the UK was the launch of LMAX in autumn 2010, an online exchange in which retail traders can deal directly in stock indices, bonds, commodities and currencies. “LMAX brings transparent pricing to the retail mass market for the first time,” says Tradefair’s Mr Murphy. “The exchange has no vested interest in traders losing, unlike some traditional spread betting and CFD providers. Instead, it simply makes money from the amount of business being done. This means traders can have much greater confidence when they trade this way.”
The ability to trade without delay and to set one’s own prices opens up a whole new world of possibilities for retail traders. “Automated trading is set to be the next big thing here,” says Mr Murphy. “Without having to know how to write computer code, ordinary members of the public will be able to create their own strategies to identify and even execute opportunities, just like hedge funds do.”
