FOOL SCHOOL
An Introduction To Spreadbetting

June 7, 2004

Trading shares using a spreadbetting or contracts for differences (CFD) account is a relatively recent development as far as private investors in the UK are concerned. It differs from the more usual process of buying shares through a broker in a number of ways.

 You're not buying a physical asset like a share. Instead you are entering into a bet on the price movement of a share.

 You can 'short' a share -- meaning that you can bet on it going down as well as up.

 You can also trade in variety of other instruments. For example, you can bet on indices (such as the FTSE 100), foreign currencies, commodities (e.g. gold and coffee) and even on the outcome of sporting events.

 Bets are usually only made on a short-term basis, i.e. days or weeks rather than years. So, unlike normal investing, making a profit not only involves correctly predicting which way a price will move, but also when it will move in that direction.

 Your transactions are geared. This means that you get same level of exposure to profits and losses for a much smaller outlay that you would do if you bought the underlying shares. However, you may have to pay a financing charge for the privilege of this gearing. See 'How A Spreadbet Works' for examples.

 You don't pay any stamp duty. When you buy shares, you pay stamp duty of 0.5% on the value of the transaction.

 With spreadbetting accounts (but not CFDs), you don't pay any capital gains tax on your profits. However, this means that if you make any losses on a spreadbetting account you can't offset them against other capital gains.

 Most importantly, you can lose more than your initial stake. In theory, on some bets, your potential losses could be almost unlimited. Having said that, most spread betting and CFD companies give customers the option of using controlled risk bets and stop and limit orders in order to limit their losses.

Usually you will deposit a margin payment when you take out the bet to cover any potential losses. If your bet starts to go seriously wrong you may be asked to deposit more money to cover potential further losses. Though by using the option of controlled risk bets and stop and limit orders you can limit any potential losses you may incur.

Trading with a spread betting or CFD account is definitely a risky business. It's not appropriate for anyone who has limited experience of the stock market (or other financial markets depending on what you're trading). These types of accounts will typically appeal to the more experienced investors and traders!

It's totally different from investing in something like an index tracker over the course of 20 to 30 years in order to build up a retirement fund. Investing like this will give you a little piece of the overall growth of the economy and therefore the stock market. However, when you're trading using CFDs or spread betting, your profits will come primarily from other traders and exploiting volatility in prices.

While one trader makes some money and another loses, the spread betting company always takes a little piece out of the middle. If you still decide to have a go at trading, then probably the most important thing is to remember not to try to trade your way out of a loss-making situation by taking bigger and bigger bets. As the old saying goes, when you find yourself in a hole, it's best to stop digging.

Find out more in our spreadbetting centre.