Watching Your Exposure

Getting back to money matters, it’s appropriate to think about the total exposure that you have at any particular time, across the range of open bets. After all, how many bets should you have going at one time?

The answer to this is not exact. It depends on your appetite for risk, how good you are at multi-tasking, and what sort of time-frame is involved in your trading strategy. You should probably try to have no more than five open bets at any one time, and see how well you are able to monitor them. Those bets may need you to move stop loss positions and assess their performance, and if several prices run at the same time then even five may be demanding. You may not maximise your profit by limiting yourself at first, but you will also not lose as quickly if things get out of hand.

At the risk of getting technical again, there is a gambling formula that can be easily applied to spread betting that is known as the “Kelly Formula”. J. L. Kelly wrote an article which was published in 1956, and this put forward the following proposition which relates the amount to be risked to the possible outcomes and their chances: –

K = (((B+1) x P) – 1) / B

The answer “K” is the amount that you can risk, when “B” is the ratio of the amount you can win to the amount you can lose, and “P” is the probability that you will win.

As an example, let’s take the ratio of the winning amount to the losing amount as 2:1. This is probably as low as you should go, anyway. Perhaps you will win only half the time, say a 50/50 proposition. If we solve the equation for K, we get

K = (((2+1) x 0.5) – 1) / 2 = 0.25

What does this mean? That you should have only 0.25, or a quarter, of your capital in total at risk at any time. In practice because these numbers are only approximate, you may want to make it even lower, say 0.2. If you are risking 2% loss on each bet, then your maximum exposure should be 20% / 2%, or ten times leverage on your account. You will always want to keep your exposure below this, and depending on your propensity to risk you might pick only 5 or 6 times exposure. This is actually the same as one of those rules of thumb that spread betters use, but it gives you a reason for the amount.

The way to look at your exposure to risk is to calculate the equivalent value of all your open bets, and compare that to the funds that you have committed to spread betting. If you calculate this exposure, and it works out to a ratio of one or less, as a novice that is a good value to have. If you are not experienced in spread betting, and not sure that you can trade consistently, then keeping this value at one or below may save you from an early exit.

Once you have developed your system, and feel you can win consistently – note that this does not mean that you win every bet – then you can look for a value up to two. Many people should not go beyond a value of three, even once they are consistent, because it may feel too risky and not suit their personality. This is fine, and not “weak” or “lame”. As long as you are making a profit, you can divert more funds into your account which will allow you to increase your profits.

Even once you have established great knowledge and experience, and have been betting successfully, you probably shouldn’t exceed five or six. If you find that you are tempted into this level or beyond, it is time to step back and take stock of your aims and abilities, before you have a disaster.

It’s also perfectly okay not to make a bet if there’s nothing that appeals to you, after applying your system parameters. Avoid taking a marginal bet, just because you haven’t placed a bet today or this week. Every time you place a bet, you are putting your money at risk, and you only want to do that in the best possible circumstances. Sometimes you may even feel that you are missing out on the action, but that is no reason to manufacture a bet that you do not feel good about. You should always have a positive reason for placing a bet, and having to place a bet to make up your losses from a previous bet is not a good reason!

When you invest, you will hear a lot about diversification, as you don’t want all your money in, say, real estate, or electronics. Simply investing in different companies does nothing to guarantee that they won’t all crash together – just look at the dot-com boom and crash of recent years. And when you are spread betting, even though you are not looking to stay in the bet for a long time, you should still consider diversification. While you do not have to carefully balance your bets between the markets, if, say, the oil companies are doing well you must avoid looking just at the charts and placing three of your five open bets on oil companies such as ExxonMobil, Royal Dutch Shell, and BP. It is really not very different from placing one big bet on Shell, but if you did that you would probably realise that you had too big a stake in one place – betting on different companies can mask that conclusion.

Another way that you should look at your overall betting portfolio includes what proportion of long and short bets you have. If you are betting in a strong bull market, you should expect that your bets will mainly be long ones. If you are in a bear market, you should have more short, or selling, bets. If the market is balanced, you would have some of each. If you take an overall view and find that you are going against the major market trends, then you should seriously consider what you are doing. You are putting yourself on the wrong side of the odds.