Clearing away spread betting misconceptions

SPREAD BETTING has become much more mainstream over the past decade but there still exist plenty of myths and misconceptions about how providers actually operate, leaving traders liable to be confused and frustrated. Here we clear away the some of the confusion surrounding the industry.

It is certainly not the case that the whole system is rigged against traders. Fierce competition has seen spreads narrow to just a few basis points in many cases and providers have been forced to improve their customer service and technology. Since the vast proportion of their revenues is generated from the spreads, providers have every incentive for clients to place as many spread bets as possible and to keep trading with them.

It is not just competition that has helped to make the industry more transparent and more customer-focused. Under the Markets in Financial Instruments Directive (Mifid), which was passed in November 2007, spread betting firms are obliged to offer best execution.

“This means that the spread will be fixed and the price offered to will be the best price possible in the underlying market. This also removes the idea of skewed spreads when markets are moving in a particular direction,” says Tim Hughes, managing director of IG Index. He adds: “The spread betting companies also cannot widen spreads to balance their book and they won’t be able to move spreads if they have an opinion that the markets are likely to move in one direction.”

Competition and increased volumes have allowed providers to become more accommodative to their clients’ needs. For example, GFT can deal with small and large trades and there is no requirement to deal in recognised exchange contract sizes, giving clients greater flexibility, says GFT’s David Morrison.

When it comes to the dealing book, it is a common misconception that firms will hedge by taking the opposite position to yours. In fact, the ideal scenario for a provider is that they are able to match trades without need to hedge at all.

For example, if one client goes long on the FTSE 100 at £10 a point and another is short the index at £10 a point, the two orders offset each other, leaving the provider with no risk and simply a facilitator of trades. “We try to have as many clients as possible because the more clients you have, the more likely you will get positions that match,” explains Hughes.

Of course, not every position – particularly those of larger sizes – has an equal opposite and the provider is likely to have a net exposure to a market. In this scenario, it won’t hedge every trade one-for-one because this would be expensive and impractical. Instead, IG Index aggregates its net exposure to a market and sets limits that are dependent on the liquidity and popularity of the security. Any positions that push the net exposure beyond that approved limit will be hedged one-for-one, however, says Hughes.

Finally, it is no myth that traders are more likely to lose money than win. Angus Campbell, head of sales at Capital Spreads, says that despite the fact that there are more winning trades than losing trades, only about 20 to 25 per cent of clients will make money overall. “The problem is that the winning trades are a lot smaller in size – clients run their losses, move their stops too far away and they are too quick to take profit,” he explains.

Competition and Mifid give transparency but successful traders will still need to plan and stick to their strategies.