Trading spread bets has its risks as well as benefits. Spread betting being a leveraged trading tool means that it is inherently more risky than traditional shares dealing and it is unlikely to be suitable for people who are saving for school or university fees or to help them boost their retirement. Trading on margin is by its very nature a double-edged sword, and losses as well as gains can be magnified if the market moves against you. This means that yes sure there is a potential to make a lot of money but you can lose a lot too. Needless to say it doesn’t make much sense to attempt to trade spread bets if you can’t successfully and profitably trade stocks.
We are committed to ensuring that our customers understand the risks involved in spread betting. The below are some ways to protect you from the negative effects of trading leveraged products.
How to remain in control of your spread betting -:
- We strongly suggest that you avoid chasing losses
- Use stop loss orders or guaranteed stops orders on your positions to protect your downside risk.
- Only spread bet with monies that are immediately available in order to cover any potential losses.
- Monitor the amount of money you use for spread betting.
- Always ensure that you have sufficient monies to cover margin requirements or reduce your positions.
- Should you wish to stop trading, temporary or permanently, please simply contact the provider and they will de-activate your account.
- If you need help or guidance, please revert back to the demo account or contact support or view our online trading guide
“Spread betting is definitely very attractive – the rewards can be huge and any gains are tax-free. Of course, it’s also a very quick way to lose a lot of money if you get it wrong.”“The problem is that spread betting can easily encourage over trading as it is the click of a button, ‘fast and cheap’ or should I say cheaper than some of the alternatives. I suspect that those who count among the “losers” are indeed those who are seeking a quick win rather than those dealing on the basis of research or firm convictions on the trend for example of a currency.”
The Potential Pitfalls of Investing on Steroids: What are the Risks?
“Most beginner spread traders fall into the same traps, says Angus Campbell a market analyst. These include: being unrealistic about returns; being undisciplined; and having an exaggeratedly complicated trading plan.”
The potential to leverage-up the investor’s capital increases the risks. This is another vital point for you to understand. Not understanding how leverage works in spread betting can be deadly. Unlike fixed odds betting, your risk is NOT limited to your stake. You see, in spread betting only a small percentage of your total market value of your trade (commonly referred to as the margin) is needed as a deposit in order to open a spread betting trade. This allows you to magnify your gains (and losses) potential by increasing your exposure to an underlying asset with the same initial investment, thus resulting in a possibility of spread betting losses that could well exceed your initial outlay. Traders who are highly leveraged could easily lose more than their initial capital and end up owing money to the spread betting company. Understanding the way leverage works and the true value of your trades means that you can manage your spread betting exposure and possible downsides more effectively.
‘The trouble is you can bet with money you don’t have. The danger is that you take out too many bets or put too much money down and then there is a correction in prices and you have to come up with a large sum of money.’
Using the FTSE as an example, suppose you think the party will go on forever and so you BUY March FTSE at 5200, £30 a point. You go away on holiday and the market crashes big time down to 2200. I know that’s highly unlikely but that’s 3000 points at £30 a point…let’s see…that’s £90,000! time to sell your house. The losses (£90,000) were far more than your deposit (£30 x 150 = £4,500).
In practice, the company would have closed this spreadbet for you due to the fact that you had not advanced further margin deposits for your increasing losses. Perhaps you will only owe £20,000…
You can also protect against this risk using a normal stop loss or controlled risk bet. A stop loss order is an instruction which you place with your spread betting company so as to stop a loss before it gets too big to tolerate. A stop is in effect an order to automatically close a position when it gets to a specific loss level dictated by you. For instance, if you have a long position on XYZ stock at 250p and want to make sure that if the trade goes against you, your losses are curbed should prices reach 200pm you can tie a stop loss to 250p. This would mean that if the stop is hit, your position would be automatically closed at the best available price to help prevent further losses.
Likewise, without a stop loss in place, your £30 a point spread bet on the FTSE 100 at a price of 5200 could theoretically put £156,000 of your money at risk, which would be an unacceptable risk. However, if you had linked a stop loss order so as to exit the trade if the index fell to 5100, your risk would be capped to a much more manageable £3,000 (of course subject to slippage in the absence a guaranteed stop loss).
Make sure you understand the risks you are taking before you get into this. Don’t place bets you do not understand. If you are spread betting with money you can’t afford to lose, one, you shouldn’t be investing/trading with it at all.
“Spread betting can be whatever you want it to be from an avenue into pure gambling to a useful tool for managing risk and tax. It can be more expensive than trading the underlying instrument or it can be cheaper, again depending on how you use it and what you trade.”“The real issue in financial markets is ‘RISK’ and ones ability to manage it with appropriate strategies, unfortunately most novices that enter the markets have no idea what this really means. And so when they lose their money they go looking to apportion blame anywhere except where it belongs!”
Firstly, it should be noted that over-leverage is a common mistake for those new to the spread betting game. Depending on the size of your trade, if you aren’t adequately capitalised and don’t have stops in place, just a 1% drop in the cost of a stock could leave you facing a margin call of hundreds, if not thousands. However, one point worth noting here is that it is the trader or investor who controls the risk. The fact that spreadbets are traded on margin means that the trader has only to deposit a fraction of the value of the underlying market position which allows spread traders to take advantage of small price movements in the traded asset. If the asset price moves result in the spread bet to go into profit, the spread trader stands to make a sizable profit due to the leveraged position, but at the price of elevated risk should the price of the traded instrument move suddenly into a loss. In fact this is one of the main risks – investors can easily be tempted into taking large trading positions that they do not have the cash to support. Never use leverage excessively. Some spread traders also tend to use their margin funds with just one single opening trade. If, for example, you have £10,000 in your account, I would strongly advise you against using it to do just one large six figure trade. This is bad practice as it leaves very little leeway for price movements against your position. Always hold back extra margin funds to cover your position should the markets move against you, or your spread trade could end up being closed out.
“To start spread betting, you need to deposit some funds into a margin account. If you have £3,000 in your spread betting margin account and the spread betting broker has a margin requirement of 1%, then you in theory trade up to 100 times your initial investment; i.e. open a position of up to £300,000. While this may sound like an astounding opportunity to make money it’s worth remember that leverage cuts both ways and the lower the margin you pay, the more the profit or loss will be amplified even with small price movements. You need to keep sufficient funds in your spread betting account to meet your minimum margin requirement should the trade move against your predicted direction.
I think the main problem I see with spread betting is the fact that you are buying from a market maker so you need to be careful who your provider is and also sometimes you may find be hard to exit the trade particularly if you deal in illiquid markets. Apart from that most of the pitfalls in spread betting are psychological – if you only set your bets at levels you would hold shares in real life then things like leverage and risk should be no different. With regards to spread betting being too risky, I think different people have different levels of risk with everything in life. Risk in spread betting is the same as the amount of leverage you take. Because of the leverage effect, any losses are magnified in a similar way that profits are magnified. Leverage can work in your favour or against you and you may be asked to provide extra margin if the trade keep going in negative territory. For instance if you had £10,000 to invest and adopted a very conservative strategy of only taking on spread betting positions equivalent to the amount of shares that you could actually cover with cash (retaining the non-margined market exposure at close hand in a bank), with a stop to limit your losses in line with a straight £10,000 investment – then I think that would be about as risky as buying the shares themselves. Risk in this respect is something you can evaluate and control -:
You can control risk because:
- You can simply choose not to trade in any particular market situation.
- You can choose to trade but adjust position size to take into account the likely risk. In a lottery for example there is huge risk and very high rewards, so you adjust risk by betting/trading just £1 (1$).
- As risk reduces e.g. safer stocks or government bonds your position size can increase.
- You control the leverage. If you use £1,000 to control a £10,000 position your profits/losses will accumulate at about 10 times the rate of the change in the price of the underlying assets because of the gearing effect.
- You can use risk mitigation methods like the utilisation of of stop loss orders (and in particular guaranteed stop orders) to ensure that you never lose more than you are willing to without limiting your profit potential.
- You are in control. If you place a single large trade on any one market, your success or failure depends solely on the movement of that one particular market. Open multiple positions in different asset classes and you will diversify your risk. Likewise, if you aren’t familiar with a particular market or what makes it moves and exactly how volatile it can be you are already at a crippling disadvantage. Knowing a market well can make a lot of difference as it allows you to react quickly to changing market conditions. For instance, if a spread trader isn’t aware a rise in crude oil prices is likely to impact airline stocks, they could be fighting a losing battle taking a punt on British Airways shares. An added benefit here is that knowing your markets well will help you work out appropriate stop loss levels.
“Get the ‘betting’ bit out of your head and start thinking £££s-per-point as opposed to £££s invested. If you buy £10pp of BP at 500p, you simply need to think of it as a £5k investment and not pay any attention to the fact you only need to stump up £500 deposit. Your £10pp would leave you £5k out-of-pocket if BP were to go bankrupt and became worthless. This is exactly the same as if you had invested £5k in an ISA or SIPP. If the price of BP were to rise to 600p, your share investment would be worth £6k and the £10 per point spread bet would have netted you a £1k profit.”
The problems start when investors aren’t that disciplined, and invest money they don’t actually have as cash cover. Often they don’t have sufficient monies at all, or sometimes it can be raised but only by selling other investments. In both scenarios, it’s effectively the same as borrowing money to invest which is generally a bad idea. In addition, over leveraged spread betting positions often result in traders being stopped out too early/too often. If you have £1,500 to risk in a trade, but utilise all of it with seven times leverage then you will have to stop yourself out if the spread trade moves 15% or earlier, since you actually have exposure to £10,000 worth of market exposure, with only £1,500 available to risk. This becomes even more serious when trading higher leveraged products such as foreign exchange where you might only be required to deposit 1% margin (i.e 100 times leverage). If you deposit as margin all the money you wish to risk, then you will fine yourself being stopped out if the forex pair moves just 1% against you, which, depending on your trading style, or indeed trading psychology, may well be too soon.
For myself, I price all spreadbets as stocks e.g. they appear in my spreadsheet as £1000 for 10pp. If I make 3 points then it’s £30 or 3% and not 30% as the margin might imply. All that stuff flatters the ego but the £30 is £30 whether you call it 3% or 30%. The £30 added to the pot and on we go. It is critical that you are aware as to how much risk you are exposed to.
You can also reduce risk by proper money management and stops which means that you apply stop losses to close your trades at predetermined price points, thereby eliminating the possibility that you end up risking more of your capital than you wish to. The risk on a trade amounts to the difference between the entry and stop expressed in financial terms – how much do you stand to lose if your stop is hit?
Apart from guaranteed stop losses in spread betting, all of the advanced deal mechanisms are free. Stop orders not only help you mitigate losses but can also be useful to lock in profits as well as helping you to buy at at opportune moments or sell when charting trends in particular suddenly change.
Stops should not be based on fixed percentages, but based upon what the market tells you. First the market will tell you if your assessment of market direction was correct. If price patterns, indicators, common sense tells you that you called the wrong market direction then get out as soon as possible. You can always re-enter the market if it turns and proves you right.
Market direction is the only thing that matters. You are either right or wrong.
Stops should look at what the market tells you, which is why volatility based stops (e.g. ATR) are the next best thing after readiing market direction. They tell you how far in the wrong direction you are prepared to go based upon how volatile, how irrational, how unpredictable the instrument that you are trading is in that particular market at that particular time.
“Risk rears its ugly head in so many ways! There is the risk that the company goes bust over night so if you bet the farm your homeless, but there is also the risk that you don’t make enough profit on the winners to counteract the losers. I have just been reading about the original Turtle traders, apparently they determined their position size by looking at the volatility of the instrument so that ‘in theory’ their risk of winning or losing any amount of dollars was the same on every instrument they were trading, independent of price.”“This is such an important aspect of investing. Your attitude to risk will and should be influenced by how significant the loss or gain will be. We all have a utility function for money which is not likely to be linear. If you have £1M the utility or benefit from gaining a second £1M is much lower than it would be if you had very little. I have also come to see risk in terms of total assets or wealth not just equity/bond investments. Many people have large sums tied up in property which could easily fluctuate downwards by 10% losing them tens of thousands of pounds, but fail to acknowledge this risk and consider staking even £1000 or £2000 of savings on shares as nothing but reckless gambling. In the end trying to minimise risk can be the biggest risk of all.”“To get significant reward you normally have to take an element of risk. Excessive risk taking is madness but so too is avoiding all risk because by doing so you will also avoid reward. You have to accept the losses in the same manner you accept the gains and your trade size and stops should be set at a level to deal with the risk.”
Having been a spread trader for several years I can say with confidence that there is nothing inherently wrong with spread bets. There are a number of spread betting providers where you’ll come across some dodgy practices, but there are ones that are OK as well. As a trading product spreadbets are wonderfully simple. However they involve very high levels of leverage and if you are too stupid or too greedy to understand the implications of that you deserve to lose your money. In this respect the main problem with it is people using it inappropriately. A fool and his money is easily parted and all that. Anybody who uses spreadbetting without stop losses is an ignorant fool.
To conclude if you don’t use maximum gearing, and trade sensibly, spreadbetting is a wonderful tool. Much like using a hammer, if you don’t watch what you are doing, you will at some stage have a bad day. Using up your entire cash balance as margin for a single opening trade is invariably a bad idea not least because market volatility is inherently unpredictable in the very short-run. Additionally, some spread betters tend to overtrade, which isn’t good. The problem is that some find it too addictive and they get hooked. The tendency can easily be to overtrade – you get a buzz from it so you force yourself to go and start betting on all sorts of things. I have certainly had my losses (generally compounded by waiting too long to accept that I am wrong) but this is way offset by major gains. However, at no time do I have positions which could stretch my finances and so I have the luxury of patience which maybe is another virtue that the losers do not have. Whatever you do always have ample extra margin to cover your positions should prices move against you.