Spread Betting on Shares: Good to Know
Michael Hewson, senior market analyst at CMC had this to say. 'Stocks tend to come in two categories, defensive and cyclical. As a general rule defensive stocks are a lot more stable and less volatile which makes trading them a lot more predictable, but also much more time consuming and hard work simply because they don't move much.'
'As a trader, the quickest way to make money is to search out stocks that have a high Beta. Beta is a measure of volatility and risk based on general market movements. For example, a Beta of 1 suggests that the price action of a security will move in line with the market benchmark.' Normally the market is assigned a Beta of 1.
'A Beta of less than 1 means that the asset will move in a much less volatile fashion while a beta in excess of 1 indicates that the asset price will be much more volatile than the market. A Beta of 1.2 means a stock is 20% more volatile than the market benchmark. Conversely, if a share has a beta of 0.75, that would mean that if the wider market increased by 10%, this share would likely only return 7.5%, however, if the market dropped 10%, this share would likely only move down 7.5%. A higher beta implies higher risk/potentially higher returns. With that in mind, when looking at the FTSE 100 the higher beta stocks will be in mining and financial services given recent concerns about the growth prospects and the solvency of the European banking system. The stocks in the FTSE 100 with the highest Beta are Vedanta Resources with a beta of 2.6, Antofagasta 1.9 and Anglo American 1.9. In the financial services sector Barclays has a beta of 2.2, Royal Bank of Scotland 2 and Lloyds Banking Group 1.9.'
Another variable is 'Alpha' which measures share price volatility based on the particular characteristics of the particular fund or share under examination. Again here, the higher the number, the higher the risk.
Other Things to Know when Trading Shares
- Most shares are referenced with Epic codes. Epic codes are short names usually consisting of initials of the company, that the exchange uses to refer directly to that company - for example, Barclays is BARC.
- In order to price so many stocks the spread betting providers have automated the process - dealers now work on a software package that takes the current share price of any company, increase it to reflect interest rates, decrease it to allow for dividends foregone and the end result is in effect a futures price for each company.
- Shares are the fastest growing area of financial spread trading and many of the largest US, UK, European and Australian stocks can be traded through spread betting firms.
- The day-to-day fluctuations of share prices can be calculated using a spreadsheet and historic prices; this is crucial for determining appropriate stop loss/limit order levels. Alternatively, analyse a stock's past data to determine past what you recognize to be a small and probable daily move and what you consider to be a big and unlikely move. In academic terms the probability of a move of a given magnitude in a financial variable is usually accepted to follow the normal distribution, also called the Gaussian distribution which consists of a bell curve, with a high probability of small changes and ever diminishing probabilities for large positive or negative moves in the variable. Deviations of more than 3 standard deviations would be considered extremely improbable (this may not be exact as quite big moves in the market are not only more common than this would estimate but are also difficult to predict. The so called "Fat Tail" distribution).
- A useful exercise to do before investing in any stock (or stock tip from a pal at the pub!) is to plot two charts of the underlying share; once showing the recent performance on a day-to-day basis over the last, say, 3 to 6 months and another showing the weekly performance over a number of years. This will allow you to gain a graphical perspective of any suggestion. For example is the share near a recent peak? Most novice traders fall into the trap of buying into a rally at the top...
- When trading stocks in general avoid trading against the trend. A good idea is to wait for the trade to pull back, i.e. if the stock is moving up, let it retrace to a level and bounce. Choose an entry level where the price bars are small in length - not overly elongated i.e. volatility and hence risk should be small.
- Another strategy might be to set the stop loss at a level that is unlikely to trigger - but in the occurrence of the stop loss being triggered it would not result in a wipe-out. Likewise the limit order can be set at a point that is highly probable, such that the potential losses are large compared to the possible win, but the probability of the win is significantly larger than the probability of the loss. As the probability of a small movement is much more likely than a large move, this strategy would results in many small wins with the occasional big loss. However, on average the total sum of the losses should work out to be less than the total sum of the wins. Monitoring bets and changing stops to trail the price in winning positions would improve the return of this strategy. Note that I don't usually recommend this strategy as I believe the potential reward should always outweigh the possible loss.
- A comment on investing in Funds; investing in funds is not a bad idea but you should avoid the fashionable ones, investing in them always turns out to be a mistake. There is a belief that when Fidelity comes up with a new fund, that's the end of the trend. It makes sense. It takes a long time to set up a fund, so by the time the big fund managers have spotted a trend and set up their funds, the trend is over.
- The fundamentals in any given market are usually most bullish near market tops and most bearish at market bottoms. This is where the 'buy the rumor, sell the fact' anecdote sometimes comes into play.
- In practice it is worth noting that shares should always outperform interest rates and bond yields. It's really a case of getting paid for taking a risk. Why would we invest in stocks if we could get the same in return from bonds? - we wouldn't. Fixed income returns are about as low as they get. You can't get less than sweet f/a. So there is only one way to go long term and that is up. As rates rise so will share prices. If we are at a 40 year rates low (not sure about that, I haven't checked) then it's reasonable to assume we could get a slow 40 year up cycle but I'm more inclined to think it's part of the overall long term trend that says stock markets rise more than they fall.
Trade Forex or Shares?
- The forex markets are less volatile than shares and for this reason forex trades are usually more leveraged than share trades to multiply the movements.
- The cost of trading in forex is a pure ratio of the amount leveraged. Trade with more money, the cost goes up to match. In stock trading the cost of trading in shares diminishes as capital increases (which is why a minimum balance is required to even bother attempting stock trading, else commissions chew you out).
- Forex markets have less structural bias: you can use much the same strategy to take long or short positions (a short position is the equivalent of taking a long position on the inverted pair). Whereas with stocks, bear movements tend to be sharper than bull ones (panic is a greater motivator than greed, perhaps!).
- In shares all movement is constrained between a set open and close, therefore all business must be completed between the open and close (or risk holding overnight if so inclined). unless you sleep-in; there is no sleeping-through some random spectacular movement like can happen in forex, and if something is going to move it HAS to move between the open and close i.e. less data to wade through and movements are 'real' due to their time-constraints to get moved and be over and done with.
- In my experience, traditional technical indicators work better with stocks than with forex; after all, that's the market that they were originally designed for (although it may work better for the main currency pairs). Forex is definitely more liquid with trading virtually round-the-clock 24 hrs a day but it seems that forex trading requires more 'specialist' market knowledge, and is more complex in some respects. For example, when you buy/sell a stock, you have only one company to consider, but a forex pair reflects the perceived strength of two nations' economies, relative to each other. Longer term, forex tends to revert to a mean, partly because government intervention tends to redress imbalance in a nation's economy. (For example, I might buy a stock today at 50c, and in two years time it might be worth $3.00. NZDUSD is currently 50c. When will $1 NZ ever be worth $3 US? LOL). The stock market is almost completely speculative in its nature; forex includes large 'commercial' transactions; IMO greater diversity of participant objectives = greater randomness in price movement.
- Volume can be a very useful indicator with stocks, and Level II (market depth) data is available with many betting providers; neither of which is available in forex (at least to the retail trader - an information type that I really miss). Stocks can give you hundreds of candidate companies to consider, in different industrial sectors, while forex is limited to pairs involving a few major currencies, i.e. greater opportunity (especially for hedging) versus simplicity of analysis, take your pick.
- Forex has a smaller 'pool' of 'real players' (we are not real players. we don't move the market and do not even really exist in the market... unfortunately we are purely players in a shadow-game). How can one expect to predict the intentions of a handful of players who may, or may not, be influencing each other in various random ways? In forex it is quite likely that most significant and 'real' movement are purely day to day businesses doing their day to day things which cannot be predicted with charts, darts, or farts ;) Stocks have 'real people' 'really playing' and the volume is actually readable, and potential crowd behavior can be gleaned and chart patterns found and analysed. You can even move the market all by your little self if so inclined with your more realistic capital.
- Forex is a continuous 24 hour market, while stocks tend to have overnight gaps and spikes. Hence there are more candle patterns (islands...etc) available for consideration in stocks. With foreign exchange trading, there is greater liquidity, and hence less propensity for slippage in trades, while with stocks, smaller companies' prices can arguably be more easily manipulated. However, with stocks influences on price movement are more relative and relevant, and not some random butterfly turning left instead of right somewhere on the other side of the world.
>> Trading FTSE 100 Shares
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