Twelve years ago, on a rainy afternoon when nothing much else seemed to be happening, I abandoned my desk in Canary Wharf for a few hours in order to track down a new and obscure betting operation somewhere off the Mile End Road. The managing director was a large, florid man in his late forties. He smoked a succession of fat cigars and looked the picture of ill-health. No medically-minded betting man would have offered better than evens on his survival into the new millennium.
The business he ran belied his appearance however. The office, in a quiet cul-de-sac, was newly fitted out and spotlessly clean. The trading screens were impressively up-to-date and there was a buzz of excitement. It all pointed to the presence of serious money behind the operation — which, so my host hinted more than once, there was.
I had alighted on a spread-betting firm, whose primary function was to offer its clients — then mainly City professionals — the opportunity to make leveraged bets on movements in financial markets. All deals were done over the phone — no deadbeats cluttering the hallway here. The clientele, I remember, included a surprisingly high proportion of South Africans. ‘What you’re seeing here,’ Mr Unhealthy insisted, uncorking another bottle of Chablis, ‘is the start of something big. Spread betting is the way all smart people are going to trade in the future.’
Having long since lost that bet on his own life expectancy, my host is not around to see the day, but his prediction was pretty much spot on. Spread betting and its posh-sounding sister, trading contracts for differences (CFDs), have become the medium of choice for many 21st-century financial punters. So much so that IG Index, the largest spread betting firm, boasts a market capitalisation of £890 million, ranking it as the 240th most valuable company on the London Stock Exchange. Its business, according to its latest results, is growing at more than 50 per cent per annum.
City Index, IG Index’s main rival, is also growing fast. It has been owned since 1998 by Michael Spencer, the very rich and famously short-tempered founder of the moneybroking firm ICAP, who was recently appointed treasurer of the Conservative party. By a nice irony, Spencer may find himself talking donations with Stuart Wheeler, founder of IG Index, who has been the party’s most visible donor in recent years, having sold his IG shares for £30 million or so in 2003.
According to Clive Cooke, the (very healthy-looking) chief executive of City Index, his 25,000 clients now include not only City types but a good number of private individuals, many from the professions and an increasing number from overseas. Doctors and dentists are among the most active: if you find it difficult to get an early afternoon appointment in Harley Street, it may be because 2.30 pm, when Wall Street opens, is one of the busiest moments in the trading day.
‘The average client,’ says Cooke, ‘is 25 to 55, predominantly male and middle class, but not super-rich.’ Having an account with a spread-betting firm is about having fun as well as making money, he reckons — which figures, because although he won’t be drawn on precise figures, it is common knowledge that the majority of punters who trade in financial markets normally lose money over the course of a year.
It is not hard to see why spread betting and CFDs have proved so popular. Once you have an account at a spread-betting firm, you can bet 24 hours a day, using a sophisticated online trading platform that offers you up-to-the-minute prices (and freedom from prying eyes), as well as news feeds and charting services. The choice of instruments you can bet on includes quoted shares on all leading stock markets, bonds, commodities, interest rates and currencies. Not only are bets on shares exempt from stamp duty but any gains you make from spread bets (though not CFDs) are tax-free. You can also bet on prices falling as well as going up.
And the real beauty of these toys for boys is that you can trade ‘on margin’, meaning that you only have to put up a fraction of the amount that you choose to bet. Trading on margin is a form of credit which magnifies both your gains and your losses, as all types of financial leverage do. For the first time, therefore, an account with a spread-betting firm gives you the chance to play at running your very own hedge fund.
Spread bets and CFDs work in different ways, but the underlying proposition is identical. The main difference is that spread bets are made directly with the bookmaker, who will typically lay off the bet elsewhere, whereas with CFDs the other side of your trade is taken by another counterparty in the markets, the bookmaker in this case merely acting as middleman.
This is how it works. Suppose you want to bet that the share price of Marks & Spencer will rise. Instead of investing, say, £7,000 to buy 1,000 shares at £7 each (paying broker’s commission and stamp duty), you buy a CFD at £10 a point instead — which means that for every penny the M&S share price rises you will make £10. If the price of M&S shares rises by 10 per cent, your conventional share purchase will show a profit of £700 on your £7,000. But with a spread bet or CFD, your outlay ‘on margin’ will typically have been just 10 per cent of the value of the shares, in this case £700. If the shares then rise by 10 per cent, you make 70 points at £10, which is also £700 — so instead of a simple 10 per cent return, you’ve doubled your initial stake. The flip side is that if the shares fall by 10 per cent, you lose your entire £700 outlay. Spread-betters can protect themselves against a really nasty fall by putting in place a guaranteed ‘stop loss’, which the bookmaker will typically set at 5 to 10 per cent below the price when you place the bet.
Confused? It’s not hard to get the hang of it once you start. A spread-betting account is a fast, exciting way to test your wits against the markets minute by minute, as professional traders do. The average City Index client has an active trading account of around £5,000, but seasoned pros routinely bet with much bigger sums. Some accounts at City Index, says Cooke, have as much as £5 million in play at any time.
With all main markets rising strongly at the moment, spread betting has never been so popular. Five out of every six bets are struck on the basis that X, Y or Z instrument will rise in price: punters find it a lot harder to bet on prices falling. In these conditions, probably even the dimmest punters are making some money. That will keep them coming back for more, even though you can be sure that the markets will in due course turn and bite them badly. That, too, is part of the game.
Jonathan Davis edits Independent Investor.