Trading up a gear

With interest in retail trading techniques showing signs of significant growth over the coming years, Philip Salter asks whether you should trust your broker?

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.