Q: What are the Risks?
A: What are the risks of spread betting? We have to tell you that there is risk involved in spread betting or for that matter any leveraged traded product be it CFDs, options, futures or spreadbets. Yes, you can make money but you can also lose money. That is the ultimate risk involved making a loss.
The risks of spread betting are obvious.
The greatest is to your money. Full stop. You will often notice the prominent warnings attached to spread betting firm’s adverts and websites telling you about the risks of spread betting.
This is is for a very good reason, not just an order from the FCA.
⇑ ⇑ ⇑ ⇑ Listen to our podcast summarising the potential Dangers and Trading Risks of using Spread Betting to Trade.
YOU CAN LOSE YOUR MONEY!
If that makes you tremble, leave here and resume whatever else you were doing before.
Quite often spread betting firms will use terms such as ‘gearing’ and ‘leveraging’. These are terms that were originally used to describe the risks associated with Futures.
In spread betting they basically mean the same thing.
You can lose more than you stake. (although with ESMA rules these days retail clients cannot lose more than the amount that is in their brokerage account!)
Just because you bet a pound for every tick/point that the FTSE 100 moves up, that doesn’t mean that you will only lose a pound if the FTSE100 goes down.
If the FTSE 100 moves down 10 ticks/points, you lose £10, 50 ticks/points = £50.
You can multiply whatever the movement is against whatever you stake. So you can imagine the losses you might get hit with if you are betting £10-£100 a tick/point.
The point being you lose more than you originally bet. But if that makes you feel nervous, just stick to the age old ‘adage’ of not risking more than you can lose.
This is not secret information, and I am not trying to put you off, but hopefully the reason you’re here is because you are serious about financial spread betting, and want to learn how to do it with an extra edge, and reducing the risks of spread betting.
In spread betting terms that means starting with and staying with small sized stakes (the minimum) until you are comfortable and familiar with the platform or platforms you are using. In addition to this, you need to find the right market to trade. Most importantly you need to develop a systemized approach to trading that will lead to consistent spread betting profits.
If you are not making money with the minimum bets, why would you up your stake?
Do not ever get in the frame of mind where you feel that the market owes you, or putting on trades for luck, or the worst of the lot, spread betting with an ‘all or nothing’ sort of mentality. Try and get a clear idea of where you want to get ‘into’ trades and ‘get out’ of trades. This is important, both to stop out losses and to take profits.
Many spread betters find that by paying attention to this blog, that they start getting an idea of what to look for, namely good technical analysis levels, coupled with how to use these levels.
WARNING: beware of subscribing to any technical analysis services offering trials or any other gimmicks, they are usually run by people who don’t actually have the balls (and yes, you do need these) to trade themselves.
Our spread betting guide is definitely a good place to start.
I cannot overemphasize this point enough, get an idea of the levels to look for, and an idea of what to do at those levels. If you don’t, you’ll end up feeling like you are just gambling, or listening to the latest news annoucement for guidance, a complete waste of time.
This leads me on to the other risk, that being the risk that is connected with any kind of betting.
You might like it. Yes, it might become addictive.
That’s a good thing if taking on the challenge of spread betting in the financial markets and winning appeals to you. But if you are doing it the wrong way, then it’s a bad form of addiction, and you will ultimately lose.
You might want to make big money fast, and stake too much too soon, this is a common mistake of not just spread betters but of any sort of short term traders. Like any form of gambling, the bookmaker always wins, no matter what, and they win for that reason.
What’s the hurry?
Day trading or spread betting is not a quick fix, get rich game. If that’s what you want then you’ll find plenty of quick fix, get rich schemes on the net. The risks of spread betting should be noted.
Think about what you are doing and why you are doing it, take it slowly.
Most traders will tell you that at some point in their trading career they have made a loss or at least one losing trade. If they say they haven’t then they are probably not being honest with you or themselves.
Even the best traders don’t always make a profit. But, there are things you can do to try to ensure your profitable trades outnumber your losses.
Even the best traders don’t always make a profit.
Spread betting is a leveraged product, you’re controlling a much larger position than your deposit would normally allow you to trade in the underlying market. The advantage of this is that your winning trades can return much greater profits.
However, you also run the risk of your losses being magnified in exactly the same way. Managing your risk should play a crucial role in your trading strategy.
The greatest risk with spread betting is a lack of understanding of the product; in particular inexperience and ignorance. The way spread betting works is that it typically involves initially depositing only a small percentage of the total trade value so losses can quickly exceed your initial deposit requiring you to make further payments (especially in the absence of stop loss orders!).
When buying stock in a company, assuming the worst case scenario, the shares could become worthless and you would then lose your entire initial investment. Place a spread trade and you could lose more than your initial stake and be obliged to deposit extra funds to cover your losing trade. This is because spread trades are margined products, permitting you to take large market positions in relation to the money deposited and thereby amplifying your profits and losses.
Many people find themselves balking at the thought of risking money, and this can be considered the first hurdle to overcome. There is always risk involved in investments, regardless of whether you are in real estate, opening a bar or restaurant, investing in a start-up company, or any other endeavour. But no one makes money without taking risks.
Two important aspects to understand are the concepts of the stake per unit and stop loss functions. If an investor does not understand that whatever they bet is based on a ‘per unit of change’ contract, he will expose himself to bigger risks than he had intended to and then end up shocked when he loses big amounts of monies. It is also important to understand how stop loss orders work as these can help to control risk.
Most beginners tend to utilise too much leverage and they end blowing their account. The difference between those that are successful and those that aren’t usually revolves around position sizing and prudent risk management. As David Jones at IG Index puts it one of the worst things that could happen when you start trading is to have a string of winning trades. ‘You think you’re invincible…but then bang, suddenly it all blows up in your face.’
Spread betting is just a mechanism for trading a market so the risks you have are arguably threefold -:
-> the risk of your spread betting provider going ‘tits up’ which I would add is highly unlikely and even then as a UK segregated client you have plenty of protection. This has never been something that has troubled me – there were one or two ‘bob outfits’ that went out of business last year but as a segregated client you do not have too many worries here.
-> the market risk; if the market is moving against you and you are on the losing side. But that’s how markets work!
-> leverage – spread betting/options/CFDs/Futures being margin products means that you don’t have to put up the full value of the trade. So you could have, say, a £10,000 position on British Airways and only have to tie up £1,000 from your account. The upside here is, of course, that if British Airways moved up 10% you could close the position and you would basically have doubled your initial investment. But that doesn’t mean it is risk-free – leverage cuts both ways and if British Airways goes down 10% you would end up losing your whole margin deposit.
How Risky is Spread Betting?
Spread Betting is high risk due to the fact you are trading on margin. But as long as you have a prudent risk management strategy (not trading too big compared to your account size, using stop loss orders…etc) trading on margin need not be scary. I would not recommend compulsive gamblers use spread betting or CFDs, but for people who are disciplined and cautious, it can be a good way of profit enhancement. Remember you do not have to use all your money on just one trade and you don’t need to use the leverage at full capacity – start small and build up.
For instance I know one particular very successful trader who holds spreadbets (long termers and short term) but doesn’t use the leverage that spread betting providers offer. He simply makes sure that his total holdings in shares value does not exceed his cash funds value. That means he is fairly free from emotional trading and has not no possibility of receiving a margin calls (the curse of spreadbetting).
How Can You Manage Your Risk?
On the upside there are a few tools and techniques that you can use to help manage risk when you are spread betting.
These items will be a combination of features you can use on the trading platform provided by your chosen spread betting broker and also skills that you can learn through experience. We have put together our top tips for managing spread betting risk…
1. Always use a stop loss, always…
A stop loss is an exit order that is used to limit the amount of loss that a you will take on a trade, if the trade goes against you. For example, if you are long on a trade, and you want the price to move upwards, you will set a stop loss to exit the trade, if the price moves downwards too far.
2. Always set a target and exit point
A lot of traders focus on entry into a market i.e. looking for the perfect conditions to press the button, and send the order over to the broker.
Yes, this is important. However, research shows that the most successful traders spend just as much time defining when they are going to exit a trade as they do on entering a trade.
You may not always hit targets but at least you will always know what your expected outcome is. This will help keep your trading structured and objective. Try and keep emotion out of the equation.
3. Be aware of economic news & announcements
It is true that news and economic announcements effect the markets. When you are spread betting you need to be aware of news items that could have an impact on the price of the underlying market(s) that you are trading.
The impact of news on a market is usually an increase in price ‘volatility’.
There are many methods on how to manage news and announcements. Our view point is “News is News” and the general impact on the market is usually an increase in price “volatility” i.e. the up and downs of price can be quick and move a lot of points in a short space of time.
Now we know what will happen to market prices on news announcements but how do we know what events are coming up and when? The best way is to keep an eye on an economic calendar. There are many economic calendars out there but we like the one over at our friends FX-Street.
4. Have a plan and stick to it
To help you manage risk and stay objective it is important that you formulate a trading plan and stick to that plan. Within you plan you should include what your approach to risk is. Also keep in mind that this risk is relative. A large risk to one trader may be an acceptable level for another.
The managing director of a spread betting provider recently pointed out that the average client on its trading platform typically bets £1 or £3 and in a year may spend only £1,800 – hardly the behavior of an addict.
