Trading up a gear

Finan­cial spread bet­ting and con­tracts for dif­fer­ence (CFDs) are on the rise. This increase in demand sug­gests sat­is­fac­tion, but many pop­u­lar trad­ing forums are burst­ing with crit­i­cisms of the indus­try.

While that may be true, it’s fair to say that the loud­est voic­es rarely speak for the major­i­ty. An Invest­ment Trends sur­vey, con­duct­ed in July 2011, found that 88 per cent of the 12,296 spread bet­ters asked, rat­ed their bro­ker as either very good (40 per cent) or good (44 per cent).

Spread bet­ting and CFDs haven’t been around for long. The for­mer was invent­ed in 1974, when Stu­art Wheel­er, founder of IG Group, cir­cum­vent­ed the pro­hi­bi­tion on British cit­i­zens spec­u­lat­ing on the price of gold by mak­ing his own mar­ket.

CFDs came into to being in the 1990s, extend­ing over the decade from insti­tu­tion­al hedge fund clients into the retail mar­ket.

Spread bet­ting and CFDs have a lot in com­mon: “Both are deriv­a­tive prod­ucts, both track the instru­ment prices in the under­ly­ing mar­ket and both have a degree of lever­age attached,” explains Bren­da Kel­ly of CMC Mar­kets. Mean­while, IG Mar­kets’ Chris Beauchamp says: “The tax-free ele­ment of spread bet­ting is the fun­da­men­tal dif­fer­ence between the two – any win­nings on spread bet­ting are auto­mat­i­cal­ly immune from the taxman’s clutch­es [cap­i­tal gains tax].”

Direct Mar­ket Access offers a solu­tion; no bro­ker inter­ven­tion, price trans­paren­cy and guar­an­teed under­ly­ing mar­ket prices

As well as grow­ing, the mar­ket has changed. Spread Co’s Ian O’Sullivan notes: “In the last five to ten years, spread bet­ting and CFDs have gone from being a tool to trade equi­ties to an increas­ing­ly pop­u­lar way of trad­ing cur­ren­cies, com­modi­ties and indi­cies.”

Joshua Ray­mond, of City Index, says he has seen the amount of trades placed on City’s indices mar­kets increase by 177 per cent over the past two years and the vol­ume of trades placed on their for­eign exchange mar­kets increase by 82 per cent over the same time peri­od.

With this mar­ket growth has come addi­tion­al scruti­ny. Those com­ing to trad­ing for the first time are right­ly start­ing to ask whether the bro­ker is real­ly on their side. The answer is yes, although they should­n’t expect any favours. All major bro­kers hedge their net posi­tions in the under­ly­ing mar­ket, mak­ing their mon­ey from the spread (the dif­fer­ence between the buy and sell price). As such, they don’t prof­it from your loss­es – in fact, they would rather you win so you car­ry on trad­ing. The bro­kers aren’t char­i­ties, so if you’re try­ing to buy or sell in a mar­ket when every­one else is doing the same, you might get requot­ed, strug­gling to get the “on-screen” price.

Most bro­kers are mar­ket-mak­ers, set­ting prices that may not track the exact price of the under­ly­ing. This fact leads some traders to believe their bro­ker is out to get them.

How­ev­er, mar­ket forces mean that bro­kers have to track an accu­rate price or there would be oppor­tu­ni­ties for arbi­trage and too many requotes will lead traders to switch bro­ker, although most have mul­ti­ple accounts any­way.

Nev­er­the­less, for traders unhap­py with the mar­ket-mak­er mod­el, direct mar­ket access (DMA) offers a solu­tion. With DMA, the bro­ker enters the under­ly­ing exchange on behalf of the client, ensur­ing an exact price. Matthew Mur­phie, man­ag­ing direc­tor of FP Mar­kets, the largest DMA CFD provider in Aus­tralia, now mov­ing into the UK mar­ket, explains: “All client orders flow direct­ly on to the rel­e­vant under­ly­ing exchange or mar­ket with­out any inter­ven­tion from a deal­er or mar­ket-mak­er, enabling clients to receive price trans­paren­cy and guar­an­teed under­ly­ing mar­ket prices.”

What­ev­er a trad­er decides, any dis­sat­is­fac­tion is eas­i­ly solved in the five min­utes it takes to open anoth­er account.

Financial spread betting and contracts for difference (CFDs) are on the rise. This increase in demand suggests satisfaction, but many popular trading forums are bursting with criticisms of the industry.