Greed and Understanding Risk
Spread betting is like every other form of gambling, there are do’s and don’ts. Here are some pitfalls to avoid….
- Risk, when it comes to shares, is something very subjective. Companies operate in very uncertain enviroments. Different investors/traders will analyse those risks differently. But they are still risks. If you think the odds are slightly tipped in your favour, then by all means take a position. But risk is risk, and even if the odds are tipped slightly in your favour, sometimes you will lose. Even with a coin weighted towards heads, sometimes it will come up tails. This is why diversification is important. If you carry enough eggs then a few might be bad but there’s a good chance one came from a golden goose.
- When considering spread betting you must examine the potential benefits and weigh them against the potential pitfalls in order to determine whether or not the risks are worth taking. Since financial spread betting allows stock market traders to make tax free gains, there being no Capital Gains Tax on any income made coupled with the fact that spread betting allows you to go short or long, the potential for profits can seem unlimited at first glance. And, for the sharp intelligent experienced trader, that may very well be. But in order to get to that stage, you need to take steps to learn how to minimize the risks involved.
- Naked greed is a real killer and the reason for overtrading and oversized positions. People want to use their leverage to get rich quick. Sure, you can risk something crazy like a third of your capital on a trade and get it right in a big way and make a ton of money in no time. There were people who habitually shorted in 2000-2002 and pyramided outsized positions and turned a few tens of thousands into over a million pounds. Many lost it later. If you trade with outsized positions you will get wiped out quickly. If you are fortunate and get some big wins due to the strategy the day of reckoning is postponed. Sooner or later you will lose big if your position sizes are mad. Be patient.
- Be careful trading the indices especially on larger stakes! I mainly trade positions on shares as it allows me to concentrate less time on watching every tick as you can set stops at your pre-determined exit points and the volatility isn’t so high, remember that for every stock in the FTSE that moves through a range per day times that by 100 and you have the index (obviously) people tend fail to look at the basics of what they are trading, and trade a silly £200 per point, for me I would need to have over £250k in an account to trade that big.
- Watching a stock (penny share) rise by 40% in one day, and getting greedy and holding and consequently watching it (over the course of 2 weeks) drift back down to BELOW the original level. Why didn’t I sell after the first day?? In a word… Greed. Why didn’t I sell during the next 2 weeks? Simply because I ‘believed’ it would continue to rise. Why? Because everyone on a forum felt it would go north further, and I wanted it to!!! How stupid!!!!
- Likewise, avoid big offside trades and leaving them running for too many days (which ties up margin that could be used elsewhere).
- Failure to stick to a staking system. A staking system tells you how much you should bet on each event and gives you a maximum loss for each set period of time. Failure to stick to this could result in you ‘chasing’ and losing money. Unfortunately, a common mistake amongst beginners is to risk everything on a couple of positions, which is just about the most certain way of wiping out your account early…
- Failure to properly understand risk – this is not just about stake sizing (position sizing) but you also need to understand the correlation across different stock market positions held, stop loss levels, volatility in the underlying markets…etc. And if you hold a number of longs and shorts, it is even better… If you can’t properly evaluate the risk in your trading, how can you hope to control it?
- Diversification – i.e. concentration risk is also about correlating markets. For instance if most of your portfolio is long USA subprime mortgages…you may have some geographical diversity (Las Legas, Miami, Florida, South California…) but you still have big exposures to house prices falling and people defaulting on debt.
- Eliminate unnecessary distractions. I find it consumes so much mental energy to be effective in this game… I struggle to trade with any commotion around me and need peace and space, no phones distracting me every few minutes…etc. If you could lock yourself away in a padded cell with the internet and the odd bit of Bloomberg and an occasional walk around a lake, it’s probably my version of a perfect environment to trade!
- How much money do you want to make from trading? £1000 per month? £2000? £5000? Lots? Don’t know? Don’t know is not really an answer and will generally lead to failure as it means you don’t really believe that you’re really going to make much. You need something tangible; something with a direction – you need to adjust your frame of mind and think of a constant additional income contributing to your bank account. And the trading income ultimate goal has to be at least equal your current income as otherwise your mind will not really consider the goal as worthy of much work and thus it will be demoted on the basis of unimportance.
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