More and more active traders are turning leveraged products like CFDs or spread bets rather than plain share dealing. Spread bets are a type of derivative mimicking virtually any kind of financial asset and are used by traders and investors to speculate on the underlying market’s move. Of course spread bets being free of capital gains tax also makes them particularly attractive to traders who are going to be in the market a lot. Because of the ability to trade on margin, such instruments allow an investor to get exposure to a certain asset class for a much smaller initial outlay. They also tend to thrive in periods of high market volatility and spread traders typically opt to utilise high leverage to amplify their gains.
If you find yourself swinging from elation to depression with every one penny move in the price of Marks and Spencer and the effect it is having on your account balance, then it could be the trading gods’ way of telling you that maybe you should scale back the size of the position. Figuring out the direction for a market can be tricky enough at the best of times. Trading at a level that makes sense, based on your risk capital, can help you look at the markets from a balanced viewpoint, and not get caught up in the minute-by-minute swings.
Workings of Leverage
With spread betting you benefit from the full movements of the underlying stock, but you may only need, say 10% of the money to open the position. This works the same whether you trade stocks, indices or foreign exchange (actually with indices or forex you might only need 5% or less). So, for instance, with Facebook trading at just $32, and let’s say you wanted to acquire 1,000 of these. Normally, with shares you would have to stump a $32,000 deposit. But with spread betting, you might only need 10% of the market exposure to open the position. So, instead of putting $32,000, with a $3,200 deposit, you can control $32,000 worth of Facebook shares.
Obviously leverage also dramatically increases the risk – the more leverage you have, the greater chance of bigger wins but also the greater chance of bigger losses as well and the bigger the losses the harder it is to recover . This is why stops are so important to limit the downside risk. Remember that if you suffer a 25% loss on your account, it takes 33% just to get back to breakeven point. A 50% drop means that it will take a full 100% just to recover.
The leverage linked to financial spread betting means that any gains are substantially magnified, although this also means that you could potentially lose a lot more than you originally paid upfront. However, if you want to improve your chances at being successful you really need keep leverage to a sensible level which will reduce the need for stops. In fact if you set up a spread betting in the same way as you would if you had bought actual stock, then you wouldn’t have to worry about stops, unless you want to trade and not buy and hold. You still get more shares for your money.
I try to keep the majority of my positions sufficiently margined that I can allow the share price to lose at least 30% before I get stopped out, sometimes as much as 50%. Always with stops, so I can’t lose more than I have. Bigger bets are more emotional, ‘loss aversion’ causes us to concentrate on the possible loss instead of the gain, and this actually causes the market to move against us! Sounds unlikely I know, but that’s what makes it difficult to comprehend!
Do I always do this? No of course not. Some of my bets are very highly margined, but I do that for short periods of times as a speculative bet, which I accept I may lose. You have to know what you’re doing with spread bets for sure….and many unfortunately don’t.
You are right that your own psychology is of the essence. Take the figures you gave. At £1 a point, if it moved 100 points against you, you’d think nothing of it. But at £25 a point you’d be watching the chart second by second – if it moved 10 points against you (extremely likely) you’d start thinking, what have I done? I believe nothing produces bad decisions more than trading at an uncomfortably high level.
We are definitely in a game which is quite difficult, overtrading is most definitely an account killer as is greed as is letting a losing position runaway. Demo accounts although not perfect should be a first port of call and the argument goes you shouldn’t go onto cash until you have doubled a demo 3 times, bit of a tall order but at least double an account once so that it shows your planning and strategy works then go onto small stakes. Also, don’t chase your losses as this will usually lead to more losses, know when to call it a day – you dont get paid for overtime in trading in fact it’s usually the opposite.
Note: Just because the leverage is there doesn’t mean that you have to use it. If you buy something in a spread-betting account and you are up to your maximum gearing in that account it is still okay if you have the cash at hand elsewhere. I have an allocated amount for me to use for trading and that’s that! – If I can only afford £1000 worth of shares in cash terms – I won’t go and buy £10,000 in the spread betting account. If all my shares crashed heavily then I would still be able to pay the spread betting companies straight away. Also, I don’t necessarilly just recklessly hold onto anything in my spread betting accounts – if the market is tanking and so are my bets I’ll take the profits as you can always buy back cheaper if you still like the shares!
The leveraged trading products available now include financial spread bets, contracts for difference, covered warrants and turbos. What these trading products have in common is that, for the same initial outlay, they offer superior exposure than you would get when investing directly in the markets. They also give you the flexibility to sell an asset short as well as going long.