Before you begin spread betting it is important that you fully understand the risks involved.
Spread betting is a leveraged product
With any trading product that is said to be ‘leveraged’ the profit and loss potential becomes highly magnified. Leveraged products, also known as ‘margin’ products, usually require the investor to outlay only a small percentage of the total cost of the underlying asset. The magnification of potential returns on investment is a key reason for the increasing popularity of financial spread betting.
Let us then explain the effects of leverage using a simple example:
Let’s say that you wanted to buy 10,000 £1 shares in ABC Company. If you were to buy the physical shares you would need to outlay the full 100% of the consideration so in this case £10,000. If you chose to buy £10,000 worth of ABC Company using a leverage product such as Spread Betting you would be typically be asked to deposit only 10% of the total consideration (£1,000).
If the share price of ABC Company increased or decreased by 50p the effect on the total profit or loss in the above example would be the same for both the physical purchase and the spread bet. However, the percentage return on investment would be very different.
Profit Example: £10,000 initial outlay = 10,000 £1 share x £0.50 profit per share = £5,000 profit and a 50% return on initial Investment.
Loss Example: £10,000 initial outlay = 10,000 £1 share x £0.50 Loss per share = £5,000 Loss and a 50% loss on initial Investment.
Profit Example: £1,000 initial outlay = 10,000 £1 shares x £0.50 (profit per share) = £5,000 profit and a 500% return on initial investment.
Loss Example: £1,000 initial outlay = 10,000 £1 shares x £0.50 (Loss per share) = £5,000 Loss and a 500% loss on initial investment.
The above example of loss using a leveraged product highlights the point that it is possible for an investor to lose more than their initial investment. However, there are a couple of tools and techniques available to you to help you limit the risks that we have highlighted above.
Top 3 tips for managing your trading risk
Do your homework!
Have a strategy – Know how much you want to make - or the most you want to lose - before you enter the position. Translate this into actual price levels, both on the upside and downside.
Know the instrument – Be aware of: average daily/monthly price movements, liquidity (how much can you trade in a single order?), the available trading hours, the trading costs, price influencing factors, fundamentals etc.
Be aware of impending announcements: If you are speculating on the price of an individual company - when does it report? If you’re betting on a the price of currency pair – what major economic announcements are expected
Utilise Stop Loss orders
After you have an idea for a trade, use the tools at your disposal to manage the possible outcomes of the trade. Protect your capital with stop loss orders.
Be disciplined, avoid moving stops loss orders further against you.
Choose the right type of order; ensure that the order covers the duration of the position. Use guaranteed stops, especially when trading products that are not quoted 24-hours.
Ensure that contingency orders are managed carefully - if you close a position, ensure that all orders that you linked to it are cancelled too.
When placing a market order the trading platform will allow you to input your own stop orders. To make things simple you are able to input a ‘total loss’ figure which will automatically calculate the appropriate stop price for you.
It is a feature of the WorldSpreads ‘Limited Risk Account’ that an automatically generated guaranteed stop order will be applied to every market order placed. By attaching a guaranteed stop order to every market order the WorldSpreads Limited Risk Account guarantees that you cannot lose more than you have initially invested
Monitor your open positions and available trading resources
Be organised. The account is yours, it is your responsibility and you are trading with your capital. We are here to help you and we have provided a feature rich platform in order to assist with your risk management but if you don’t organise yourself then open positions will continue to generate P&L.
Trade within your means. Ensure that your account is well funded and that your trading resources are always well in excess of your allocated margin. There is nothing worse than not being able to take the next opportunity because you are holding onto an existing trade that has not gone in your favour.
Understanding Risk Conversions.
The following table shows some conversions from ‘pounds-per-point’ to underlying market exposure.
Margin trading is the practice of buying or selling financial instruments on a leveraged basis, which enables clients to open...
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