“I can calculate the movement of the stars, but not the madness of men”. This quote, ascribed to Sir Isaac Newton after he lost a fortune in the South Sea Bubble, came to mind this week amid the regulatory clampdown on the spread betting industry.
The Financial Conduct Authority is concerned that many individuals do not understand the risks of using contracts for difference (CFDs) on online trading platforms. Essentially a way of betting on the stock market, CFDs allow you to speculate on the future price movement of anything from the FTSE 100 to individual shares or currencies with a few taps on a smartphone. Tempted to have a punt?
What if I told you that 82 per cent of people taking out such contracts ended up making a loss? The FCA made this calculation via a sample of industry data. That is a staggering number — but here’s another. The average result, per client, was a loss of £2,200.
Reading this, you might think “well, you can’t legislate for stupidity”. But what concerns me about this regulatory battle is how easy it is becoming to interchange the terms “investing” and “gambling”.
As CFDs are typically leveraged trades, it is possible to make big bets with a relatively small amount of money in your client account. Just as a magnifying glass can concentrate the power of the sun’s rays, if you get it right, you could win big. But get it wrong, and you could be frazzled like an ant, your losses will also be magnified and you could end up owing the platform much more than your original stake.
The FCA has raised “significant conduct concerns” about the amount of leverage being offered – some firms offer in excess of 200:1, but it can go as high as 500:1 — saying this can lead to “rapid, large and unexpected losses”. It proposes that leverage should be capped at 25:1 for inexperienced traders, rising to a maximum of 50:1 for the more sophisticated. It is also consulting on beefing up risk warnings and greater disclosure of profit-loss ratios.
This is not the first piece of research to demonstrate how easy it is to lose money using CFDs, nor will it be the last. But just as Newton found, the statistics are trumped by human greed. Even faced with such steep odds, people can psych themselves into believing they are the “special one”, capable of predicting future market movements, or winning the lottery.
Regulators might describe them as “retail investors”, as speculating on market movements forms the basis of their trades, but where does investing end and gambling begin? It all comes down to your assessment of risk. For example, I wouldn’t borrow money to bet on a horse. But I have borrowed a lot of money to buy a house.
The same applies to investing. When used correctly, investing on the stock market is a wealth-creating engine for our long-term savings. When used incorrectly, it is little more than a casino. No form of investing is ever risk-free, but neither is staying entirely in cash. Inflation will eat away at your savings, and you will also lose the valuable benefits of your reinvested dividends compounding over time (that is one magnification effect I’m happy to experience).
Of course, not every short-term trader is unaware of the risks. Many FT Money readers will use spread betting as a means of shorting shares, hedging risk in investment portfolios, or as a tax-efficient way of trading (these are derivative trades, so you never actually own the underlying assets). The FCA’s leverage cap proposals won’t prevent you from doing so in future — but if you want to respond to the consultation, go to the regulator’s website.
However, the voices that are largely absent from this discussion are those who have lost money. The Financial Ombudsman received 79 complaints against spread betting companies from April to September 2016, with misunderstanding of the risks involved being the central theme. Given the FCA’s sample data, I’m surprised it wasn’t higher.
What concerns me is how many people I meet who believe that any form of investing is like gambling on a casino. This year, FT Money teamed up with think tank Britain Thinks to investigate why more women were not investors. At our workshop, women told us that they thought investing was “too risky” and the majority of their savings — and long-term Junior Isas for their children — were entirely in cash. None of them, including a maths teacher, knew what a dividend was.
At a couple of recent events I’ve attended on this theme, I’ve asked the audience to put up their hands if they would describe themselves as an investor. A few hands typically go up. Then I ask them to raise their hands if they have a pension. Then we get a forest of hands.
You’re investors too, I say. Unless you are lucky enough to be a member of a final salary scheme, you need to be aware that you are responsible for choosing the funds your company pension is invested in and that the “default” option may not be the best choice.
Being an investor is about asking questions, assessing risk and having the confidence to make decisions (if necessary, with advice) that will serve you well in the long term. Anything less is a gamble.