Is Spread Betting OK for a Complete Novice?


I found this site a few weeks ago, read it from start to finish, and it inspired me somewhat. I've since been lurking on the advfn pbb quite a bit, have read the daily commentary and am reading anything that I can find really, especially on spread betting.

What attracts me to spread betting is the very low minimum deposit required to start, mainly because my realistic starting budget is £500 and I don't think that this would go very far elsewhere. Do you think that this is a good idea for a complete novice though? It is quite common for people to say on the forums that novices should steer well clear and start off in regular stocks, but if I stick to my plan and don't let my heart rule my head, would you agree with them?

From a base of £500, spreadbetting is certainly more flexible than buying and selling shares in the more conventional manner, where you could not sensibly afford to split the capital over more than one stock or two, and could not afford a wrong choice, and where dealing costs - competitive though they nowadays are - would still inhibit.

Were I starting from scratch with £500, as a complete newcomer, I would spreadbet rather than own shares. Initially I would stick to whatever is the minimum stake the spreadbetting firm will allow - just to get the feel of the mechanics of how it all works.

Because of the way spreadbetting works (i.e., allowing bigger market exposure than a straight cash purchase of shares would achieve) it is very important to always be aware of what your market exposure is, and what worst-case outcome you are able to accommodate if your selections go wrong.

Spread betting newbies are often appalled when they realise just how much money can be staked on one single bet. However, taking into consideration that you are betting a sum per point of change, you need to be careful about the amount you stake per point. If you make a £50 stake bet for instance, and the share moves 40 points, which is only £0.40, then suddenly you are £2000 richer or poorer, depending on your bet. You really need to familiarise yourself with an asset's movements and how quickly a company's share price value can fluctuate, before you start betting larger sums of money.

If, for the sake of arguing, you are looking to stake stake £1 per point on the upward movement of a stock currently priced at say 165/167p in the market, and are thinking of allowing it several weeks to come good, you might ask the spread betting firm for a December quote. Quarterly bets are probably the timeframe best suited to beginners, in my opinion, even though the firm will be adding slightly more spread within their quote than if they were offering a daily or weekly bet.

Quarterly bets expire (at almost exactly whatever is then the mid-market price) on the Tuesday before the third Wednesday of every third month (!). So a "near quarter" bet opened now will expire when the market shuts on Dec 19. A "far quarter" bet opened now would run till March 20 2007. In each case the bet can be closed anytime - even within seconds of opening it - if you think it advantageous to do so (or disadvantageous to stay onboard), in which case you will be closing the bet at whatever is the opposite end of their latest quote.

A spread betting firm might typically add 0.6% to the market spread if quoting 'near quarter. That works out at about 1p onto that 165/167 stock, giving a total quoted spread of 3p. That part is easy to calculate beforehand. Less easy is guessing where they might 'centre' their quote, in relation to current market price. If it is a stock on the up, growing slowly month by month, it is quite likely their quote will be somewhere ahead of current market. So they might be quoting say 169/172p. Were it a stock perceived as being in decline, their December quote might be say 163/166p. Other factors (such as a scheduled dividend qualification date occurring within the chosen timeframe) will affect the positioning of their quote.

Bear in mind that if market perception of a stock's prospects undergo a serious change, the 'directional skew' (the positioning of a quote ahead of or behind the current market price) can switch - and in doing so, the quote may (quite fairly) shift to a bigger degree than the market price has. (ie, the market price of a stock that was growing but is now steadily falling, may have dropped say 10p. But if the spread bet quote was running 12p ahead of the market and is now say 6p below it, the quote may have moved against you significantly more than the market has swung).

If you accepted that 'buy' quote of 172p and staked £1 per point (ie, one quid gained for each penny of upward movement in the share price) and the market price advanced to say 183/185p by say Nov 7, and you decided this was running ahead of expectations, so felt inclined to cash in, and found they were then quoting it at 184/187p, you would 'sell' at £1 x 184p, banking a net gain of £12. Had the share price moved against you quite soon, to say 160/162p (and perhaps being now quoted 159/162) and you felt inclined to not stay onboard, you would be banking a loss of £13 if closing at that point.

Your total exposure at the time you opened that bet - i.e. the maximum you would lose if the share price crashed to zero - was £172. Assuming you don't make a habit of selecting stocks which plunge to zero, your actual losses, when they occur, should mostly be a lot smaller than the maximum (which is calculated as price(p) x stake(£) ) Note that a £1pp stake equates to holding a hundred shares. £10pp equates to a thousand shares.

The firm will set a limit in the value of bets you can open, in relation to your cash balance (or credit limit if using a credit account - which a beginner should not do) - but this does NOT limit your potential losses, which can be unlimited (that floor of zero is the ultimate risk on an up bet, but on a down bet there is no ceiling if the bet goes the wrong way) - unless you close it fast or employ a 'guaranteed stop loss'.

A guaranteed stop loss (usually unavailable on smaller stocks) ensures that your loss is limited, even if the market or stock crashes beyond that level. But you pay additional spread for the privilege (effectively an insurance premium). A non-guaranteed stop loss costs nothing - and will appeal to someone who wants to ensure their bet gets closed if the price drifts too far the wrong way while they are at work or not watching - but it will be activated 'at or beyond' rather than 'at'. So if the share price (thanks to some overnight news) opens a long way from where it closed, the non-guaranteed stop loss will be activated at wherever the firm's quote now is.. having breached the agreed S/L level.. and that can be miles away. This triggering of non-guaranteed stops, where caused by some very temporary spike, is a major pain for spreadbetters who find themselves stopped out of a good position at a loss. Arranged stop losses are marketed as if they exist for the protection of the bettor - in reality the frequency with which they get triggered by spikes can make them a burden rather than a benefit. It takes quite a while to acquire a sense of whether stop losses are a help or a hindrance, and how close they should be set, and whether to pay for guaranteed ones. Much will depend on the style of the individual player and the kind of stocks they choose.

Personally I rarely employ guaranteed stop losses - but I fully understand their appeal, and they are sometimes very sensible. I do sometimes employ non-guaranteed ones - but the way I do so is too complicated to explain here!

P.S. One of the most beneficial aspects of spreadbetting for me is the ability to gradually reduce or increase the scale of a particular bet, without incurring the costs which this would entail if buying/selling shares for real. This is of major significance to me. (Though it won't be of immediate use to any newcomer who is already operating with a minimum stake).

 ...Continues here - Pros and Cons of Spread Betting

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