Spread Betting allows you to be involved in financial trading with a much smaller outlay than with other forms of financial trading including traditional share trading. This is because financial spread bets are a leveraged instrument. Financial Spread betters don’t buy the underlying asset they are speculating on, instead they speculate on the movement of the asset price. The movements in price positive or negative in percentage terms can be considerably larger than that of the initial stake. Spread bets are meant to be the instrument that provide traders with the most bang for their buck, with leverage allowing individuals to make a big profits or losses with only a modest initial outlay.
Anyone who is currently speculating with spread betting is most probably quite significantly leveraged. Leverage involves either using borrowed money or using derivative instruments such as CFD’s or financial spread bets. These means that many Spread betting transactions require only a modest outlay in order to gain exposure to a much larger sum. A Spread bet that gave you £10,000 worth of exposure but only required an initial margin of £1,000 would make you levered 1:10. The extra £9,000 is being effectively lent to you by the Spread betting company and this is typically why you are charged on an overnight ‘rolling’ charge to keep the position open into the next day of trading. This interest is typically charged in accordance with some base rate, most typically the LIBOR.
Your are still exposed to £10,000 worth of risk. However if the price of the instrument moves in your favor you will never need to deposit the additional £9,000. However, if things happen to move against you’ll have to provide the additional funds as needed or close the position. This is called a margin call. Making leverage a double edge sword helping you when things go in your favor and hurting you when they go against you. Using Spread Bets or CFD’s you will have at least 10 times exposure to price movements (some regulated CFD brokerages leverage up to 1:888). Assuming ten times leverage and a buy order, if the price rises 10% the trader would have doubled his original capital, however if the price had fallen by 10% he would have wiped out and received a margin call.
Imagine a situation where you had £500 deposited in your Spread betting account. And you were about to put down a £5 per point bet on a company whose shares where valued at 100p a share, if you were levered 1:10 then a 10% fall in that particular companies share price would wipe your account out. This demonstrates the importance of using leverage carefully, if you had only £500 in you account it would be much better to have only placed a £1 bet which would have only lost you £100 if the companies share price had fallen by 10%.
The ultimate cost of higher leverage is higher potential losses, but it does come with the possibility of higher returns which is one reason so many people are attracted to trading leveraged financial products. Traditional investors who undertakes margin Share trading can expect to make huge profits during bull periods as the leverage would massively multiply his profits, but in bad years he would either have to accept huge losses or escape the markets. However the spread bettor has the option to trade both bull and bear periods due to the fact it’s easy to trade both long and short. While a margin stocks trader does have the option to short sell it is generally more costly as it involves borrowing stock often at quite a high rate of interest.
Leverage can quickly wipe out your deposits, and this is why you should probably lean on the side of caution when its comes to how much leverage you expose yourself too. If you have only a £1000 in your account you probably want to limit the size of your spread bets to a couple of pounds. There are a number of different tools which can help you deal with the looming specter of highly levered losses. Both stop losses and guaranteed losses can help you set limits to your losses. But leveraged trading doesn’t necessarily need to be more risky if traders take the required precautionary measures. Leverage means that with a small additional deposit huge profits can be made for example, it may be possible to make a £1,000 profit from only having deposited £500 provided you have the required leverage and the position goes in your favor. Because of this there have been rare cases where people have been able to grow a £1,000 deposit into a million within the space of a couple of months.
Leverage and risk shouldn’t be too much of a problem, as long as you keep the bets small as a total percentage of your capital. Implementing guaranteed stops and stop losses will also help you control the risks associated with high degrees of leverage. The real problem many will have with leverage is psychological there is always the temptation to ramp up the leverage in the hopes of making your losses back which can put your account on a real tilt and lead to even greater losses. Which is why setting trading limits is a very important aspect of trading and is something that everyone should do.
