High Gearing, High Risk

“Spread betting is gambling, not investing.” – so says the London Times, which also says that the Gambling Commission found serious problems developed in almost 15% of spread betters compared to 1% of other gambling. Whether you count it as gambling or trading, there is no doubt that spread betting can involve large profits or large losses because of the leverage granted. The way to avoid the latter is to make sure you know what you’re doing and understand the risks.

Spread Betting Is Tempting but Wow!!! Can It Hit Hard!!?
Losing Money: How to Lose Money Spread Betting

Like other financial instruments, spread bets have risks and rewards. Financial derivatives in general involve gearing or leveraging your trading capital. That is the point of trading with them. If they did not, then you might as well just be buying the stocks or commodities directly. Futures, options, contracts for difference, Forex, spread betting, these are all leveraged financial products that give you the opportunity to make much larger profits than regular investments. The other side of that coin is that your losses can be large, too.

“There are potentially huge rewards, but because you can bet whatever money you like on each share, there is a risk that, in exchange for a relatively small outlay, you can end up with a large exposure to an individual stock. This means any losses will be magnified, rapidly exceeding an investor’s initial deposit. Like doing anything that takes risk, however, you can take precautions to help minimise its impact.”

It seems that the chief problem is that market participants are tempted into trading because of the promise of high returns, without fully understanding the mechanics of the derivative that they are dealing in, and without knowing how they can protect themselves from taking too big a loss if the individual trade does not make a profit.

It is the pure temptation of utilising extra leverage that is the principal danger for the beginner trader. Using anything like full margin can easily result in a margin call if prices were to move against you. If you cannot quickly access extra funding, your trade may well be closed for you.

Perhaps one of the problems is that the UK resident is too familiar with regular betting, such as on a horse race, and in such betting all you risk losing is your initial stake. Spread betting, on the other hand, can involve you losing much more than your account, so someone coming to it casually can be caught out.

“Most spread betting beginners tend to blow themselves out by taking on too much leverage, taking on too large positions. The difference between those who continue and those who don’t usually boils down to position sizing and good risk management.”

Ways for Controlling the Gearing/Leverage

With such low margins and markets that can move up or down sharply in a day, it shouldn’t come as a surprise that you may incur losses that largely outweigh your deposit. Having decided that you want the benefits of high gearing of your funds, such as you get with spread betting, then you have to work on ways to mitigate the risk of loss, and the amount of loss. These are two different aspects of money management, and you need to have a plan to deal with both.

“As with any margin traded instrument spread betting can be highly profitable or uniquely toxic, depending on how they are used.”

Firstly, you need to reduce the risk of loss, which means you should try to increase your winning percentages. Now it depends on the market that you are spread betting in, whether it is individual stocks, indices, commodities, or other financial instruments, but you need to educate yourself on the way that the market moves, researching the fundamentals and applying technical analysis techniques to gain some insight into the market sentiment. You will not eliminate losing trades, but you can increase your percentage of winning trades. Use money management wisely.

Secondly, when you have a losing trade you must make sure that you do not allow it to run to the extent that it cripples your account. It is essential to work out in advance how far you will allow the loss to go before you accept that the price move you anticipated is not going to happen. Spread betting companies provide resources for you to limit your losses automatically, and you need to be using one of these resources every time that you place a bet. Principally, this is done by utilising one of a number of stop loss orders that spread betting providers offer, which will effectively stop you out of a losing position before the loss turns out to be catastrophic. For peace of mind, and to avoid having to continually monitor open spread trades, stops – most of which are offered free of charge are well worth using.

If you just dive into spread betting you are likely to lose your money…
Make no mistake.
Investing is different to trading and if you invest you are likely to make money but you have to spend time in the market and not try and time the market.

It is risky business.
If you try spread betting without the right stop losses you can lose big very quickly…

I tried trading full-time for a while. This followed on from a period of successful investing when I had made very substantial returns. I quickly learned as above that there is a major difference in trading from investing, and that whilst one can make a number of small gains it is also very easy to make some bigger losses – of course these can be limited by stop losses, but can you be that disciplined and then having made a loss stay out of the market and not overtrade?

“Does betting big necessarily mean that you take big risks?”

Not always according to Henry, an experienced technical chartist. For instance spread betting £350 per point is quite acceptable with say a 5 pt stop on 1% capital risk per trade any account size over £70k or 2% risk per trade on any account size over £35k. It’s a simple proven risk strategy which protects against wipe out so long as you keep to the same % risk to capital at all times. It doesn’t mean your capital can’t shrink but it gives you plenty of time to consider whether you are going in the right direction. I reckon if you were going in the wrong direction you would get seriously p***ed off emotionally and pack up long before any serious damage to your capital. The real danger is trading without a capital pot for protection – i.e., trading from wages.

“Make sure you research and understand spread betting rather than simply listening to mass media myths and scaremongering.”

And lastly, if you have lost a lot of money in the markets, you need re-examine your trading strategy. If you are unwilling to put in the time and effort to formulate a strategy to succeed then you should honestly have no speculative dealings in the financial markets.