What the Spread Betting Companies Don't Want You to Know
What the spread betting companies don't want you to know...
Spread Betting in itself isn't evil and can be lucrative if used properly but you also have to be keep in mind that the spread betting industry is still in its infancy with new providers still entering the field. The following article tries to discuss all the bad experiences that have been reported over the past years.
Gambling or Trading?
The thing that I can never get my head around - one thing that just about everyone agrees on -: 85% of traders lose money! Even 85% of fund managers, with vast resources, fail to beat the index. And the spread betting companies benefit from this
Then come along the 10%-15% who make consistent and substantial gains - a rare breed (we all agree?). If you run a spread betting company and face this situation with a large number of small losers and a small number of very big consistent winners you would face a dilemma on how to deal with the 'suckers';
1) They could lay off the bets. This is expensive for them and assumes they can lay off the bet. My guess is that they don't generally do this other than to make sure all bets as a whole are within risk tolerances. Some spread betting firms have however publicly stated that they net off the trades internally and either carry the risk or hedge only the net exposure. Obviously, it's a lot cheaper/easier for them to hedge just the net risk than hedging every single position.
2) They could side with you. I call this 'front running' or 'matching the trades' and happens in 'real' markets too; after all, you've got the stats to back up that their system is profitable, rather than an advertising sales pitch.
3) Normal trade size restrictions limit the spread betters exposure to very successful traders/strategies thus preventing a trader ever to make a 'large' amount of money. However, the press story about "The Plumber" of around a year ago implied that he was running a spread bet of £ several thousand per point.
4) Checking the profitability of instrument lines. If there are unprofitable instruments (meaning customers are finding real edges against the house) they would stop trading that instrument or adjust their pricing model (especially where there is no off setting market) .
5) Review a customer's profitability over time and place restrictions on successful traders. Whilst there has been some evidence of this it doesn't seem to be widespread otherwise the Internet boards would be full of traders complaining although there's plenty of anecdotal evidence of Deal4Free doing this...
High Gearing/Leverage = High Risk
No doubt leverage is a great thing if you know what you are doing - but it is perilous if you don't have a clue. Few people care to admit to themselves that they don't know what they are doing.
To fully understand this we need to examine past history because events and circumstances have a tendency of repeating themselves in time. The evolution of spread betting is very similar to the evolution of the 'Bucket Shops' on America's East Coast in the late 1800's. I suggest that everybody has a read about Jessie L Livermore and his experiences with the 'Bucket Shops' in the late 1800's/ early 1900's. Direct comparisons can be made between the modern day spreadbetting Companies and the Bucket Shops. It's a similar pattern of evolution which is simply taking place 100 years later. It is another example of a cycle repeating itself.
In essence these shops would hedge very little if anything. They knew that their 'products' offered such huge leverage. The net result was that the punters had the odds stacked massively against them - a small move in the market against the punter would often result in the loss of his / her entire pot. That's why GOOD MONEY MANAGEMENT and CAPITAL PRESERVATION are so important!! For one if you lose your capital your can't spread bet any more or can only bet very small amounts. And second if you lose 50% of your account, you've got to make 100% just to get back to even.
Do Spread Betting firms really hedge?
A recent article on Investors Chronicle mentioned how one very active spread better started encountering trading restrictions and later.
As a better-than-average trader, he did not fit into the normal mould of a loser, and yet he still liked to bet small - between £1 and £10 a point. After placing a £2-a-point position with one leading company just after markets open every morning - and winning most of the time, at market opening times - he suddenly found that the spread-betting company no longer quoted Nikkei prices for the first five or 10 minutes of the trading session.
This account clearly presented a problem for the company concerned. Too small to hedge (as the Nikkei contract is bigger than £1 a point), the account was showing a consistent ability to win. The spread-betting company simply used its power to decide what prices to quote, and when, and then ceased to make a market during the time period concerned. Another firm stopped him trading via the internet after a large monthly gain. This highlights a fundamental problem with spread betting.
Cases like the one mentioned above are not uncommon. Some of the spreadbetting companies do not hedge all of their positions. This means that your win is their loss. It could well be that the case highlighted above is based on someone who was trading a 'grey market' (for those people who don't understand the term, a 'grey market', it is a market which is made entirely by the spread betting company. This could be an index which is quoted 'out of hours' for example). Therefore it is possible that the customer's position simply could not be hedged. This means that they assume the full risk. Therefore if someone is very good at calling a particular market then it becomes financially sensible for the quoting company to move the goal posts slightly until the customer's advantage is lost. The experienced dealer knows that there are several ways of 'moving the goal posts'. Refusing orders or delaying executions are just simple examples of a company gaining an unfair advantage over a customer. The problem for the customer is explaining that situation to the regulatory authority in a manner which they will understand.
There are also a number of other points:
The companies which offer very tight spreads would find it more or less impossible to make any money if they hedged positions. Quite often the companies quote is the same as the underlying market. It is also possible that they may not be able to hedge quickly enough. Some traders for example are experts at reading L2 in certain stocks. Quite often they will spot a cascading price and dive in so quickly that quite often it is not possible for the company to take a similar position in the time available. By that I mean that in the time it takes for the punter to open his bet the position is already showing a breakeven or a profit. This is where the problem lies when a spreadbetting company takes on an experienced market participant who trades in such a manner. He or she may be an expert in only a few markets which they watch for many hours a day and also monitor with expensive software. The spread betting company however makes thousands of different prices and can not therefore be an expert in them all. The net result is that, in some cases, the company finds it necessary to manually process certain customer's orders in certain markets. This manual process adds time to execution which gives them time to inspect the order. For example, if an 'OBL has been found' rumour broke then it would be 'sensible' for a certain company to slow down its order flow in many of its markets purely because the market would suddenly make a very easy long. I hope that you get the picture. The bottom line is that split second timing can, in certain cases, make the difference between a successful trade and a losing one. The spreadbetting companies are very aware of that.
I think it was the Chairman of IGIndex who a couple of years ago admitted that they didn't lay bets off because it was just too expensive to do. He made a public statement to this effect (a friend of Gerald Ratner perhaps?). Effectively they take a view of the market each day and adjust their quotes accordingly in order to minimise damage and maximise profit. That is a summary of what I believe he said.
Execution delays
A number of the books written about Livermore mention how the bucket shops acted to protect their interests when he started to make money from them. Is it any different today? Widening of the spreads and delays in order execution are tricks which were played by the bucket shops 120 years ago. If we are honest then we know that, in this computer driven world which we now live, it is possible to execute customer's orders electronically in a fraction of a second. Ask yourself why many of these companies still route certain orders or customers through a manual dealing procedure? These companies are fully aware that an introduction of a delay gives them a chance to observe movements within the market which were subsequent to the order being placed - of course they can then use these 'subsequent movements' to determine the financial viability of the submitted order.
My own personal view is that the different companies will note your trading style and that can determine what kind of service you receive. If you scalp trade effectively (scalpers attempt to 'scalp' i.e. extract profits from small price movements using large position sizes) then you will often upset the spreadbetting companies, I know companies will argue this but that is my experience and therefore my view. More than a year ago I had a dispute IG Index which is evidence of that. IG are happy to send out advertising literature stating that 'prices are always live and tradable' and that 'the price you see is the price you get' - this is in order to attract customers to their platform. However, as you become a better trader and win money in very short time-frames you may start to get treated differently. In my case it reached a point where orders were taking almost a minute to get processed and orders were being refused based on price movements within that time. This clearly isn't the service that they clearly advertise and nor is it what the terms and conditions say will happen to your order once it is received. Thereby, swing trading and position trading strategies are better suitable for spread betting than scalping strategies.
The bet was for £80 per point. I've bet at that size many times and its never been a problem. I would however mention that the time it takes to process my bets had increased from about 3 seconds to 40 odd seconds. It seems to me like they started to monitor exactly what I was doing by manually checking each bet. However the dealer has admitted that he only decided that his price on Dow needed reviewing after my instructions to close were known to him. As he is at liberty to swing his market based on his order book then it is clear that a conflict of interests exists if they are allowed to have 'seconds thoughts" once they have priced and advertised their market prices. Obviously in this case the dealer rejected the order based on what he decided his market was after he had re-priced it, however the T&C act to protect customers from this type of situation by clear stating that the reasons for rejections based on incorrect prices should be based on prices AT THE TIME THE ORDER IS SUBMITTED. In my case the price I submitted was correct at the time I submitted it and only became incorrect with the passing of time (almost 1 minute) but IG ignored this fact because it suited them to do so.
Execution delays allow spread betting companies to see if the market is moving in a manner favourable to them or the customer, if the move favours them they simply accept the order, if it favours the punter they refuse the order on the grounds that "the price is no longer valid". This type of sharp practice does go on (we are referring to scalp trading here) and it does conflict directly with the service that companies actually advertise. There is only one reason in the world of spreadbetting why companies would advertise "the price you see is the price you get" and that is to suggest to customers that their service is in some way superior because of the ability to grab prices quickly. The fact is that when push comes to shove they claim that they have no obligation to standby anything they advertise, be it the type of service (ie WYSIWYG) or the prices. There are laws which are supposed to protect consumers from this type of rogue practice and the FSA has recently increased its vigilance and monitoring of financial promotions.
The fact is that computers can match and process deals far quicker than the human intervention that many of the spreadbetting companies use. Computers are also much cheaper, don't demand a salary and don't take lunch breaks. Staff are paid to process orders because it is financially viable for them to do so. Experienced customers will always be able to take advantage of certain market conditions if they are allowed to do so. By this I mean that fast execution does, under certain circumstances, benefit the customer which is of course to the detriment of the company offering the market.
This is where the delay in execution is particularly useful to the spreadbetting company. While your order is waiting to be executed the dealer effectively has the gift of hindsight in deciding whether to allow your order to pass at the originally quoted level. In effect this advantage, over a period of time, has the effect of making the spread slightly larger than is quoted. The obvious result is an increase in the cost of trading which is a cost shouldered purely by the customer.
And that's why phone dealing can turn convenient here - if you deal on the Internet and you start getting delays on the screen price, if they don't like it , it gives them time to change it whereas on the phone, the dealers can't do that unless they want to risk lying barefaced over a tape recorder.
Re-Quotes
If the quoted prices are honoured by the spread betting company which is usual in normal markets, all is well but trouble starts when the market has moved away from the quoted price and the dealer decides to reject your trade, and 're-quotes' you a new price.
This happens regularly with CMC and there is no point in pretending that it does not. Sadly it seems that the more successful the trader is, the more it happens (shares and indices). Traders can only talk about their own experiences and with CMC it is not a case of seeking to place the blame elsewhere. IG Index on the other hand do not carry out such practices (in my experience) but their spreads/charges are much higher.
One could say that execution delays shouldn't do much harm if your strategy is right and your finger quick. However for example, with CMC at times even with fastest finger your attempted trade will only be accepted if it is going against you. Actual experience not once, twice, thrice but several times:-
Once the mouse is clicked the order screen is frozen, no more trades can be placed, may eventually go through only if price as moved against me, Otherwise a re-quote.
Mouse clicked, order screen stays yellow, theoretically giving me a option to cancel the order as well as an option for CMC to refuse the trade. If the price moves against me try to cancel -no luck trade accepted. Otherwise the screen stays yellow till the inevitable re-quote.
Trade accepted, subsequently cancelled -reason bad price. Only the opening trade cancelled, closing trade stays valid. Had to have a 10 mins discussion before no profit/loss situation was restored- only on one occasion.
CMC, as market makers, told me that they will not accept an order for 1000 Abbey National (FTSE 100 CO) as there were no buyers. Placed limit order, price reached the limit order - no fill. When queried got a similar response, however, all of a sudden got filled, and guess what within seconds the price moved in the right direction by several pence. Forget the details, but it was about 10 to 15 pence.
Finally, the above tactics were experienced with 80, 25, 5 and even 1 Dow contract.
None of the above is made up or is sour grapes actual practical experience.
Skewed Spreads
One practice (which, again, is thankfully less common now than it was a few years ago) is to skew the spread in the direction of the market move. In other words, if the market is trending rapidly down, most people are selling, so, although the spread may be the same, the prices quoted will be that much lower than in the real market, as most people would be selling into a down move. As soon as the market looks like it's going to recover, the skew is switched around the other way. This can shave several points off a client's profit. However, it can backfire in that not only does it upset customers by appearing unfair, but those able to take the opposite trade fast enough can squeeze some extra profit out of the trade.