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Chapter 6




Peter Read, CEO and Founder of Pelican
Apr 18, 2018


How much does it cost?



On first inspection trading using a spread betting account seems free. There are no commission charges when trades are placed and profits are tax-free. This then begs the question of how they do make their money. The answer to this is that there are a number of hidden charges and one outrageous conflict of interest that all potential traders need to be aware of.


Hidden charges



The first charge is the difference between the “buy” price and “sell” price quoted on the trade ticket called the “spread”, which gives the instrument its name. If a trader enters into a long trade (i.e. he/she believes that the price will rise) then the price at which the trade begins will be HIGHER! than the price at which they could sell. Say the spread on a Crude Oil is 5 pips. Imagine a brokerage had one person buy £1 per pip and at the same time another client sold £1 per pip. In this instance the brokerage would make £1 * 5 pips = £5. If there was not a seller at the same time, the brokerage might trade in the underlying market where the underlying market spread might be much smaller. So the brokerage might hedge at a better price than you, the client. This is how a brokerage can make money on ‘spreads.’

Generally, the wider the spread, the more expensive it is for the client and thus the brokerage makes more money. Over the past 20 years, competition has driven spreads lower, so that there is not much difference in pricing across the industry. Companies have to differentiate via innovation and service.  

Another charge that is not immediately apparent is the interest on the money lent to make the trade. As we explained earlier, the trades are made using leverage. In other words, the trading platform lends you money to make the trade. The trading platform will charge you interest on the funds it lends. This will be at a higher rate than the brokerage pays when they ‘hedge’ your trade. They thus make money on the difference in interest rates charged.

The final source of revenue for the brokers is through client losses. Not all brokers ‘hedge’ off your trades and some take the other side of your trade. Market neutral brokers do not benefit from clients’ losses, as they pass on the trade exposure to another business. The fact that spread-betting firms are amongst the most profitable on the LSE shows that most traders are not profitable. Indeed, recent FCA data revealed that 82% of traders lost money in any one year. This is why it is so important to choose good strategies, be a strict, regimented trader and get training from an experienced mentor or follow an experienced professional trader. The final chapters of this course discuss what strategies are available and how to chose one that suits you.



 



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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
Between 74-89% of retail investors lose money when trading CFDs
You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.



Spread betting and CFD trading are leveraged products and as such carry a high level of risk to your capital which can result in losses greater than your initial deposit. These products may not be suitable for all investors. CFDs are not suitable for pension building and income. Ensure you fully understand all risks involved and seek independent advice if necessary.
Pelican Trading is a trading name of London & Eastern LLP. London & Eastern is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 534484. London & Eastern is registered in England & Wales, registered office at 85 Great Portland Street, First Floor, London, W1 W7LT, company number OC345870.
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