It can be easy to rush into financial spread betting without first considering all the factors. You may hear much about the risks of spread trading – after all, it is betting – but most of the criticism comes from those who do not understand the mechanisms of derivatives. Derivatives have been blamed for the financial crisis, but it is the overenthusiastic and overextended use of these financial tools that has caused the problems. That said, the risks are real, and you need to know about them in order to avoid making mistakes yourself.
“People say its risky but I think that’s only if you go into it thinking I’m going to make a fortune quickly, slowly and steady is the way to go.”
Spread Betting Risks
The chief risk with spread betting is that you will overextend your account. Because of the multiplying effect of the spread betting mechanics, what seems a modest bet can result in a major loss, instead of the major profit you are hoping for with a trade that works. A spread bet can be as little as £1 per point, but when you are betting on a stock market index that could move by hundreds of points in a day that translates to hundreds of pounds.
As an example, consider a spread bet on the FTSE 100 for an apparently small sum of £10 per point. If this moves 80 points, from 5305 to 5385 say, your bet would pay out £800. If you had instead chosen the wrong direction, and were short on the spread bet, you would have lost this much – with a simple £10 bet. This is the power and the danger of leverage.
While the major risk is derived from the leverage that you employ, there are other risks associated with spread betting. The trading platform that you use for spread betting must be clear and straightforward, allowing you to make adjustments to your open positions easily. The provider must act quickly on your instructions so that you can effectively cut your losses when you need to. Bear in mind that it is in the provider’s interests to keep you solvent and betting, as their profit comes from the spread. If you cease to spread bet, then there is no more profit to be made from you.
With financial spread betting, you can also end up losing more than you might have bargained for at the outset. Even if you trade with a stop loss, you can still end up racking losses if the stock markets ‘gap,’ or jump straight from one price to another without even trading at prices in between.
“If you’d bought a oil explorer tiddler stock for 25 cents a share and it went out backwards, as many do, your (hopefully) small investment is a goner but no one’s going to ask you for additional funds to cover. With spread betting there is a risk that not only you might end up losing your initial margin but also much more if you aren’t careful.”
Do these risks mean that spread betting is simply taking a chance? Fortunately the UK government think so, as they do not consider betting winnings as capital gains, but rather like a prize, which is not taxable. But if you spread bet from an informed stance, it does not have to be that risky. The main point is to limit your losses, as inevitably not every bet you place will be a winner.
You can set limits on how much you may lose by using stop losses, which are instructions to the bookmaker to sell your position if a certain level of price is reached. This is a common idea, used in most trading, and saves you the responsibility of watching the markets all the time. There is also a version of this, a controlled or limited risk bet, which for an extra charge included in the quoted spread will guarantee that your bet is automatically closed at the figure you ask for rather than at the market price after the stop loss is triggered.
My Story and Spreadbetting Experience
I have been a stock trader with a traditional stockbroker since 1995, and I was consistently making money on some of the blue chip stocks. For 5 years it was easy to go long stocks and close out a week later for a profit. I kept all my contracts and certificates and in 5 years of trading up until 2000 I had traded about two thousand times, in about 500 different stocks. I worked out the costs had come to £60,000 in this period.
I started in the spread betting industry in 2000 with Financial Spreads, based in Cannon street and a fairly smallish company to start with. As soon as I started in the spread betting industry my stock trading worsened. I had been sucked into some of the major flops like Marconi, Telewest and Energis. My trading downfall was not because I joined a spread betting company but because I got greedy. That is why I am still working and not sitting on a boat in Barbados. To summarise, the money management, exiting and pyramiding are very important…
Also, keep in mind that spread bet debt is enforceable by law. You could lose not only your capital but also the shirt off your back too! Déjà vu, I once lost the shirt off my back and it was rather cold and unpleasant! I’m no hot shot trader, I have been trading both spreads and shares for a number of years. At times it’s been frustrating and time consuming but the rewards have been well worth the time and effort. I don’t think beginners luck, as risk management and not running losses has helped keep me afloat. Knowing when to get out is far more difficult than knowing when to get in imo!
Please note: Spread bets are a high-risk financial product. It is important that you understand the key features of spread bets before you decide whether or not to risk your money