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Introduction to fixed-odds betting

Created:

1 April 2008

Updated:

18 November 2008

Written by:

Dominic Picarda

With fixed-odds financial betting, you can bet on movements in an ever-widening range of assets. These include individual shares, equity indices, commodities and exchange rates. This gives you the opportunity to go where the action is hottest. Perhaps you've no strong views about where stock markets are going just now, but you think gold is heading for the stars. From your one fixed-odds account you can as easily bet on one as the other.

If you wanted to deal in all these directly, you would need a whole raft of different accounts. To trade UK and US shares physically would require you to have two separate brokerage accounts. That number would increase if you wanted exposure to, say, continental European markets, too. And to get directly involved in commodities and currencies, you would probably need to add at least one derivatives-trading facility to your collection of accounts.

BetOnMarkets offers its customers bets on the main three US indices, the FTSE 100, and the French, German and Swiss headline markets. It also quotes on five individual UK large-cap equities: BP, Barclays, BT, BSkyB and Lloyds TSB. There are also 13 currency pairs. Finally, you can also punt on crude oil. And if you were to open fixed-odds accounts with a couple of different firms – which is easily done – you could widen your options even further.

Follow the links below for more on fixed-odds betting. And under those, you'll find another ten reasons to consider this exciting new form of trading.

• The mechanics of fixed-odds betting

• A bet for every movement

• Shorting the FTSE

• Advanced fixed-odds betting: arbitrage

• The fixed-odds wizard: diary of a fixed-odds trader

1. Profit from falls as easily as from rises

The volatility in world equity markets since last summer has reminded investors that buying and holding shares can incur heavy losses. In such an environment, it is useful to be able to speculate on shares going down as well as up. This can be hard to do if you’re trading equities. But fixed-odds financial betting allows you to 'short sell' assets as easily as you can buy them.

Say you think that BP's share price is going to drop from 550p to 510p over the next three months. In this case, you would simply open a bet specifying that you expect BP either to touch 510p at some point in the next three months or that you think it will be below that level in three months' time, depending on your beliefs. In a falling market, this ability to go short could prove invaluable to offsetting losses on your 'long positions' in actual shares.

There's always a worry when shorting physical equities or futures that you could face giant losses if things go the wrong way. With a conventional short position, you are theoretically on the hook for an unlimited amount. So, if the asset you're betting against sky-rockets instead of falling, you could get burnt badly. At the same time, your potential gains are capped: the most that an asset can go down is to zero, whereas there is no limit to its potential rises. In fixed-odds financial betting, you don't have to worry about a short position moving massively against you like this. You never face unlimited losses with these sorts of bets: the very most you can ever lose is your stake.

2. There are bets for almost every situation

Not only does fixed-odds financial betting let you speculate on lots of different assets, it also allows you to bet on lots of different outcomes. This is very hard to achieve with, for example, share-dealing or even spread betting. Only traded options offer the same sort of features, and you have to pay tax on the profits you make out of them. The bottom line is that whatever is going on in the markets, there's a way to make money out of it.

The underlying concept to grasp is volatility. Bets fall more or less into two camps: bets that a market will move around and bets that a market will remain static. There are lots of clever little variations on each of these themes.

For example, you can do a straightforward bet that a price will rise or fall to a certain level. But to jazz things up, how about betting that it rises to hit two levels? Or perhaps that it will rise to one level and then fall to another? The flipside of this is betting that a price will not reach a specific level, either upwards or downwards. That leads on to betting on it not touching two levels – ie, remaining in a range.

Not only will you always find a trade that can exploit the market conditions at any given moment, you can also find one that suits your appetite for risk. As with other types of betting, you can either go for 'high probability, low return' trades, which is equivalent to backing the favourite in a sporting event. Or you can go for 'low probability, high return' trades, which is like punting on the outsider.

3. All bets can be in your home currency

Trading different assets in different markets can be complicated. Say you're dealing simultaneously in eurozone equities, US-traded commodities and Swiss francs versus Japanese yen. Quite apart from the various accounts that this would require you to operate, it would also entail currency risk. So, even if you correctly foresaw how these assets were going to move, your profits could easily be reduced or even turned into losses because your home currency went up.

But this isn't a problem at all with fixed-odds bets. Whatever the market or country you're speculating on, your profits can be in a currency that suits you. So, for a UK investor, everything you do will be in sterling. The only thing you need to worry about is the way you think the markets in question are going to go.

4. Profits are tax-free

UK tax residents don't pay a penny of tax on any profits they make on their fixed-odds trades. That's because this activity is classified as gambling. So, just as you don't have to share any of your winnings with the taxman when your horse romps home in the 3.15 at Ascot, you don’t have to declare your good fortune on, say, an 'up bet' on the FTSE 100.

This is a clear advantage over direct investment in equities, commodities or derivatives. For these instruments, profits are liable for capital gains tax (CGT) at your marginal rate until 5 April and at a flat rate of 18 per cent thereafter.

In theory, you might be liable to CGT on profits if you were trading so actively that the authorities identified you as running a business out of fixed-odds betting. In practice, however, this is unlikely, since the taxman would then face a barrage of requests from bettors to offset their losses against tax.

Financial fixed-odds betting's tax-free status isn't set in stone forever, as tax laws can change. However, there's absolutely no indication that this will happen any time soon.

There is also no stamp duty incurred on transactions. This is straightforward as there has been no transfer of ownership, unlike when you're dealing in shares. You are merely betting on a result.

5. Fits into your existing routine

Don't think that trading has to be a full-time activity. While there are people who spend almost every waking hour glued to their screens, this is the exception rather than the rule. Fixed-odds financial betting gives you the freedom to decide how much or how little of your time to spend on trading.

Most fixed-odds bettors have full-time jobs. They do their betting around their jobs or in their spare time. For example, you might place trades during your lunch break or after work. Once you've got an open position, you don't need to monitor it constantly. Because your maximum loss is limited to your stake, there's no danger of the market moving wildly against you, saddling you with open-ended liabilities.

6. You can make large returns very easily

A relatively small movement in the price of an asset can translate into big gain. Consider a simple bet on the FTSE 100 going up. You place a bet that in 20 days’ time the FTSE is going to be at above 6300 – around 4.8 per cent higher than its current level. Based on a price from BetonMarket’s website, you would have to place £20.30 in order to win £100 – a return of 395 per cent. So your return is more than 80 times what it would have been from holding the physical equity or from an unleveraged spread bet.

Note that the natural 'gearing' of our bet here does not involve the punter having to use any debt. And the big profits aren’t matched by big losses on the downside. If the bet goes against you, all you lose is the stake you put down.

7. Risks are limited

Financial betting has a reputation for being risky. With spread bets, you can easily end up losing your shirt if you take on excessively large positions using borrowed money. And because financial markets can move suddenly and dramatically, it is possible to lose out even if you are using sensible risk-management techniques, such as setting stop-loss orders. But fixed-odds betting is different.

When you enter a fixed-odds bet, you know from the outset exactly how much you stand to lose in the worst-case scenario. That amount is your stake – it's as simple as that. At the same time, you also know the maximum you could win if things go your way. This will be a function of the odds when you opened the bet and the size of your stake.

Because your maximum loss is limited to your stake, risk management becomes much simpler. First of all, you don't have to set a stop-loss to protect yourself from getting entirely wiped out. And it means you don’t have to monitor your position so avidly, although it may be worthwhile to do so anyway.

A fixed-odds bookmaker will generally not lend you money in order to take positions – known as 'gearing'. Using borrowed money or gearing is a common practice in spread betting, and can help punters turn small movements in the markets into big profits. The flipside of this is that you can also end up incurring massive losses if the market goes against you. So, fixed-odds betting is much more conservative in this respect, in that the providers don’t offer the facility to gear yourself up.

8. You can end bets early whether you’re winning or losing

With a fixed-odds bet on a sporting event, you place your wager beforehand and then wait for the result. Once you've put your money down, you're locked in until the final whistle blows or when the horses cross the winning line. But, with fixed-odds financial bets, you have much more flexibility. In many cases, it’s possible to pull out early, either to crystallise a profit or cut your losses.

If you're winning a bet, then you can guarantee some prize money by shutting it early. So, whereas you would make £100 if you kept it open right to the end, you might get £70 if you decided to close the position with a few days to go until the bet expires. You might do this because you are having second thoughts about your position and sense that a negative reversal in the price might be around the corner. Or, it may be that you have spotted a better opportunity elsewhere and need to free up some capital in order to exploit it.

Similar logic applies when exiting a losing position early. Let's say your starting stake was £20. There are a few days to go on your bet. Although there’s still a chance that the asset you're betting on may come good during that time, it doesn't seem all that likely. The bet price reflects this: your original £20 stake is now worth just £8. But that's better than nothing.

9. You can practise betting before risking real money

Before pilots get to fly a real passenger jet, they have to spend time practising on the simulator. So it should be too for financial-market traders. It's hard to argue with the logic of getting comfortable with the process of planning and executing trades without risking a penny. You're bound to make mistakes at the beginning – better to learn how to avoid these without losing financially.

Speculating with 'virtual' cash is never going to be exactly the same as putting your own hard-earned capital on the line – you'll hear this argument from a lot of financial betting firms. They say that instead you should start off betting small with real money.

It's true that when you do start taking out actual positions, it's preferable that they should be small. However, before you do this, you should definitely have done a few dummy runs. If you can't even make money from virtual trades, you're not ready for the cut and thrust of live markets where your wealth is at stake.

Most seasoned traders maintain one or perhaps several dummy accounts, which they use to test out new ideas and strategies before putting them into practice via their real-money accounts.

Treat the exercise of dummy trading as seriously as if you were doing it for real. Sit down and look for trading ideas and consider how best to exploit them. It's usually best to concentrate on just a handful of markets, rather than trying a bit of everything. Work your way around the various bet types on offer and familiarise yourself with the ideas behind them.

10. It's ideal for strategy-orientated traders as well as opportunists

You can be as complicated or as straightforward as you like with fixed-odds bets. It's a great place to try out weird and wonderful 'black box' approaches. There are plenty of people who spend a long time sifting through past price data, trying to find patterns at various times of day, with a view to trading on these anomalies. This is especially true for fixed-odds bets on the foreign-exchange markets.

Of course, you don't have to be a hedge-fund manager in the making in order to make money from fixed-odds financial betting. Often, simple can be more effective. Plain vanilla bets on situations that you simply have a hunch about can be just as rewarding as trades picked out of a spreadsheet that has taken many hours of concentration to develop.

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