Spread betting is a leveraged traded product and spread betting providers will insist that you deposit a certain percentage of the total market exposure you take with them before they will permit you to open a trade. This deposit is referred to as margin and acts as a guarantee that you will honour the contract. Margin is sometimes referred to as the ‘notional trading requirement’, or NTR for short.
To open a spread betting trade, you need to deposit with the spread betting company a margin amount, which will be a percentage of the total value of the spread trade. For example, if you buy a spreadbet over ABC stock, you may need to pay a margin equal to 5% of the current ABC’s share price. The initial margin amount will be withdrawn from your account by the spread betting provider when you place the trade.
Margin requirements for each market a spread betting company offers can be found by clicking on the information icon which is located next to the instrument you’ve chosen. Alternatively, you can refer to the provider’s Market Information Sheet. Different spread betting providers will have different margin requirements for spreadbet over the same underlying asset. Margin requirements will tend to be higher for spreadbets over stocks than for other assets.
“The amount you’ll need to deposit with the spread betting provider depends on the underlying financial instrument and the more liquid the market you intend to trade, the less you’ll need to put down.”
For instance, a currency spread bet might only require a 1% margin, an index bet might carry a 5% margin while FTSE 100 blue-chip stocks usually require a 10% margin. On the other hand AIM companies with low capitalisations might require margins of 25% and more.
Margin trading is all about leverage and gearing. Spread betting is geared which means you do not have to pay the full price of the underlying stocks. The only requirement is that you deposit an initial deposit referred to as the ‘initial margin’.
Financial spread betting is a very good example of margin trading. The spread betting provider will decide on the margin requirement you are required to deposit to open a trade. So for instance, if stocks in William Hill are trading at 156.10p and you wish to buy 5000 shares, instead of having to pay the full purchase price (156.10 x 5000) of GBP7,805 you might only have to put down 10% margin, in which case you would only have to tie up £780.5 of your funds.
This also means that spread betting being a margin traded product, it allows for a much greater exposure for a given deposit. Rather than only buying 500 shares, you could deposit the margin and have exposure for 5000 shares!
Therefore you might only need 1000 quid to purchase spread betting positions in different stocks up to a value of, say £10,000. If your investment rises to £12,000 – equalling a 20% rise in the value of the position – you will in fact make an incredible 200% return on your initial investment, as you only invested £1,000 initially.
The good and bad element in it is the leverage involved….
The average deposit you require to buy a spreadbet rather than, for instance, a conventional share purchase is between about 10 per cent and 35 per cent, whereas when you buy a share you have to stump up 100 per cent of the purchase price.
The risk here should be clear. With such generous margins, it might look tempting to take on a much greater exposure and should the market start moving against your position, it means that you will still be liable in the same way as if you have bought these shares and paid the full price. If a position keeps going the wrong way, your broker will ask you to top up the account to maintain the margin requirement, referred to as a ‘margin call’. So, you really have to use judgement and utilise margin with care and trade with a disciplined approach so as to avoid any nasty surprises!
Let’s take the case where you decide to place a spreadbet on Company XYZ with a total exposure of £10,000. If the trade comes with an initial margin rate of 10%, you would need to deposit an initial £1000 into your spread betting account to open the trade. However you are still exposed to the full value of the trade i.e. £10,000. This means that should your trade moe against you, you run the risk of losing an amount exceeding the initial £1000 deposit and may therefore be required to put up more funds at short notice to keep the position open.
So even though a spread betting provider might only require you to put up just 5% margin down for a bet on a stock, generally it is wiser to put down more. And by more I mean at least 15% and setting stops at around 10%. If you deposit only 5% and the markets move against your position, a stock could easily go down 5% which would wipe you out in no time! And then should the stock bounce back, you’ll end up not only stopped out and lost your 5% deposit, but your trading mindset would have been dealt a blow!
Remember that margin is there to help you spreadbet responsibly, ensuring that you never overstretch your financial means. It is important to note that each market has a different margin requirement and that in general margin requirements are a good measure of a market’s volatility. Generally speaking, the more you need on deposit with the provider to open a position, the more volatile the market is considered to be.
The main foreign exchange pairs and the larger indices will normally have very low margin rates of 1% to 2%. For example, most traders tend to start with the FTSE 100 index or its component shares, as they tend not to require too much margin. The margin requirement for a £1 bet on the FTSE 100 index could be anything from £30 to £150 (different providers offer different margins for the same markets), whereas a £1 bet on the Nikkei might mean a deposit of £300 to £500 is required. The usual margin requirement for UK shares varies between 5% and 10% for the large and mid-cap stocks of the FTSE 350. Smaller caps including those listed on Aim are usually more volatile and less liquid, which is why they often need a deposit of 25% or more.
Remember that you can reduce your margin requirement when you go over certain thresholds by placing a guaranteed stop loss even though your buy price is minutely increased. It is also worth noting it is not unheard of spread betting providers upping margin rates at short notice – needless to say if you hold spread bets where the margin rating increases, you may be at risk of your positions being closed if you don’t have sufficient free cash available.
Spreadbets also allow you to make money from falling markets by going what is called ‘short’ but again, that’s something that needs a fair bit of homework.
Note: Bear in mind that most people live on margin. Buying a house with a mortgage is little different from spreadbets – less volatile usually, but far harder to get out of if you have to.