The Art of Spread Betting

A subscriber has asked about Spread Betting. It sounds forbidding and as though it has nothing to do with investing but that is an over-hasty assessment. I am almost entirely a spread better and it is not the fact of spread betting that makes what I do so risky but the high levels of leverage I use. You can spread bet without any leverage at all and then it is just like holding shares (you get any dividends, share splits etc.).

Spread Betting Gains Are Tax-Free

There are two main differences to buying shares in a share account. You pay interest on your position even if you are not borrowing money to buy more shares than your initial investment and you don’t pay any tax on gains. That is an incredible perk. You do not even have to declare the gains.

If you have never done it before it can seem daunting so let me give you my take on how to spread bet.

Number 1 – open an account with IG.

Number 2 – select a spread betting account. I have three spread betting accounts because I like to hold just one share per account. This leaves portfolio purchases, if I am making them, for my CFD accounts where gains are taxable. I also have a share account in case I want to buy leveraged ETFs. You can always liquidate your CFD investments and repurchase them in a spread betting account to avoid tax if the gains move into taxable territory.

Once in your spread betting account choose the share you want to buy and then select whether you want to bet in US$ or in £. I invariably bet in US$. It doesn’t make any difference. I prefer to place bets in the currency in which the shares are quoted.

The easiest way to think about spread bets is that a 1.0-point bet is like buying 100 shares (each cent the shares rise makes you a dollar). So for many US shares, a one-point bet is a serious bet. A 1.0 bet in Nvidia is the equivalent of holding around $90,000 of shares.

If you place such a bet you will see a number appear for the required margin which, for retail investors such as me, is 20pc of my exposure or $90,000/ 5 = $18,000. I normally start using the full amount of margin but you don’t have to invest $90,000. The minimum stake for Nvidia is 0.06 which is the same as buying six shares or an investment of $5,400 for which the margin requirement is $1,080.

That is too small for me. My starting stake is usually $5,000 of equity to buy $25,000 of shares. That means buying around 25 Nvidia shares or a bit more so a $0.25 point bet.

IG Will Start Selling When Your Equity Drops Below 50pc of Your Required Margin

Let us imagine you have placed your bet. If the shares go up everything is fine. If they go down you will get a margin call. If they go down a lot you will get an urgent margin call. If your equity falls below 50pc of your margin requirement IG will sell down your position until your equity equals your margin requirement. As a broad rule of thumb expect to lose two-thirds of your equity if this happens.

As a battle-hardened investor, this has happened to me on many occasions. If I like the share I will start buying again as soon as they start going up and I often find that ultimately I lose not two-thirds but one-third of my investments. This is a risky strategy. If the margin calls start again you could lose everything.

A 20pc Rise on 5 Times Leverage Will Double Your Equity

Now imagine if instead of falling the shares climb. On five times leverage a 20pc rise in the shares will double your equity. If you are a crazy, gung-ho, foot-to-the-floor investor like me you will use this spare equity to buy more shares roughly doubling your position. You can go on doing this ad infinitum and it becomes like an accumulator bet at a race course, fantastically profitable if it works out.

As my student friend says if you keep doing this strategy it is bound to end in tears. I end in tears repeatedly so you need to be more sensible than me. I am crazy, I know. Do what I say; don’t do what I do.

Start Small and Sleep at Night

I protect myself by starting small and making my big bets with profits so I nearly always come out ahead but not as far ahead as I might if I were more prudent and less greedy. You also need exciting shares in strong uptrends to make this strategy work. I try to ride a rocket, which is why I am always looking for such shares.

You can figure out as well as me more sensible ways of doing this. For example, you could make sure that every time you add to your holding you reinvest LESS than your spare equity so your leverage falls over time. My dream is a leveraged bet that you never have to cash in but run for years.

What I find myself doing is trying to tread the tightrope between using my spare equity to build a holding where further gains will seriously move the needle without taking such a risk that I am sold out.

I Am Always a HODL

One resolution I have taken is that I am always a HODL (hold on for dear life). I never sell on a margin call. IG always has to do it for me. I sometimes think 2 or 3 times leverage (instead of 5) might make the difference between success and failure but when push comes to shove I cannot do it. My gambling demon takes over like some crazy Regency guy betting his estates on the cards at Piquet. Maybe you can be more sensible than me; you can hardly be less.

Try it; start small; it can be an amazingly fun ride. Think of it as a game; that is what I do, like a game of chess where you are always trying to make the perfect move.