Pitfalls in Spread Betting

Here is the text from a friend who spread bets and is in love with FWY (a stock). The note distresses me as he has 3 kids and has put most of his savings into FWY at much higher prices than today.

"Hi, good to hear from you, catch up soon for a fry up, my treat.
Christ, I forgot you were a BB addict, freak show or what.
No I kept my Fwy, thinking about averaging down :-)

Yes I half thought about selling up a few months ago, isn't hindsight a lovely thing.
Good news is that I have a bit in cash and looking to start bottom fishing when I can stop.
myself from falling asleep as soon as I sit down in the evening.
Catch up soon.
Pete"

Now the only thing missing in this text is Pete blaming FWY's fall on a treeshake ;-) If Pete really followed his 'hunches', I think it might be appropriate for that fry-up to be on me ;-) Oh dear, indeed. So many of the mistakes we traders/investors love to make:

Lessons to all newbies in spread betting

I spend a lot of time warning people to understand that they are staking spreadbetting - they don't work out their exposure and think "It's only £50 a point" instead of thinking "that's £50,000 exposure". It is so easy to lose big with spreadbetting. And stop losses unless guaranteed don't help. You could have a stop of 58 on SportingBet but it something new dire happens and it opens at 20p, it won't make any difference. And guaranteed stops cost! I spent a lot of Friday saying to new traders - don't punt! You will at some point lose your shirt!

Aye. Many spreadbetters do forget to do the basic calculation -:

E= S x P

Exposure(£) = Stake(£) x Price(p)

Don't forget, if you open a trade by 'selling', your stop order should be to 'buy' not 'sell' again...

Classic cock-up yesterday. Went short of FTSE at 6194. Set a tight stop at 6200. Oh Well, 6 points lost never mind.
Came home to see my account in very bad shape 40 odd points down.
Don't forget, if you open a trade by 'selling', your stop order should be to 'buy' not 'sell' again.... :-(
On a similar note, went long on MKS yesterday but didn't set a stop. Was going to pull out when it fell 8 points below entry which would normally be more than enough to frighten me off. Luckily, (for once in my bleeding life) I held on.
Feeling a lot better this morning ;-)

A very important mail about the misuse and dangers of leverage from Laurent. I thank him for writing it because it is a chilling warning of what can happen if you over extend yourself on credit from the spreadbetting firms. The mail really needs no other comment from me except you should read it!

Thought I would write in to tell about my 2007 thunder loss. I thought I would tell it cause you could post it on the website and it could help other people. Also, because I've told my girlfriend most of what happened but not all.

At the turn of this year my portfolio was up 30%. I was buying real shares with my own money and I was doing well. Although I had been interested in shares for 3 years I had only really been trading for 1 full year. I learnt about spreadbetting in Jan this year and decided that if I could make 30% on my current portfolio then when I leveraged it using spreadbetting I could ...yeah you know…be a millionare by August 2007! Or something like that.

So I started trading large amounts. At the time I didn't really think much of it and I was just trading. Looking back at it, it all made sense. I was trading amounts that were 5 times what real money I owned. Before, when I was trading normal shares I could take a 10% loss and hold it because I knew it would come back up. Now, with leveraged shares I would step into a 5% loss and freak out cause of the amount. Basically as of June I was in the negative because even a small loss on these large amounts of money (large amounts of money for me) I would get scared and sell. I was losing almost every time I went for a big highly leveraged trade. Because I thought I was going to be rich so quickly my rules were very loose also. My stop rules and targets had become so loose it just wasn't funny. I would have a profit of 12% but decide that it should be 20%. The share would later turn and I would sell at a loss of - 7%. Enough 7% losses on leveraged trades and your bank balance soon goes.

After going over my past trades and losing all of my capital and going into negative (I had a loan) I realized the only time I made money was on the smaller trades I did because going into a 5% loss didn't scare me, and I could hold onto the trade if I thought it was going back up. So for the last month I have been trading smaller amounts which me and my bank account can handle. I'm now breaking even again and I am amazed at how I have been making money with smaller trades that I can handle. You read it everywhere that leverage can be dangerous and I learnt the hardest way. In the last month I've been taking 7% - 15% on my trades and doing much better. I'm only 26 and hope to be a full time trader one day. Until that time I'll keep trading within my limits and hope to get there one day.

One of the biggest mistakes I kept making when I started spread betting was by having too big a bet and too small a spread. Anyone playing this game please learn its not just about trying to make money, its also about trying not to lose money. For instance at one time in December I tried a £25 bet with a 20 point stop loss on Urals energy @ £2.79, luckily I couldn’t do this so tried a £12.50 bet with a 40 point spread.

The shares dropped to £2.46 approximately which would have made my original bet lose. As it was because I had dropped the amount and increased the stop loss my bet was still running and recovered shortly after. By april/may it was well in profit and in one week alone increased by over £1.50 to £5.60 area which I sold for a very handsome profit.

You have previously opened a position buying £10/point of the December FTSE at 5650. Several days after opening the position the December FTSE is trading at 5563. You place an order to close your position by selling £10/point should the December FTSE reach 5610.

Is this a Limit or a Stop?

This is a Limit.

A Limit is an instruction to deal at a more favourable level than the current price. The current price is 5563 and you are leaving an order to sell at 5610. Selling at 5610 is more favourable than selling at 5563, and so it must be a Limit.

A common mistake for people unfamiliar with Stops and Limits is to look at the opening level of the position, 5650, and to view selling at 5610 as a Stop (as it is a worse level than the opening level). Had the order been left when the position was opened, when 5650 was the current price, then it would be a Stop. In the problem described, however, the opening level is actually irrelevant to determining whether the order is a Limit or a Stop, as it is not the current price.

One thing I have learnt is not to close out the bet too early as prices often bounce around. I made that mistake yesterday as I had to go out and the share was dropping fast. This morning it opened up and would have put me back in profit instead of the loss.

This is a mistake we all make at the beginning I think, its always so tempting to bank a profit and equally we panic when we see it going the wrong way, especially with spread betting. I now panic far less when my bet goes against me, because so many times in the past I closed at a loss when if I had held my nerve I would have banked a profit.

As I remember reading, the great Jesse Livermore said "It was never my thinking that made the big money for me, it always was my sitting". Patience is an essential virtue in equities, as long as you had the correct reasons for buying in the beginning of course! Never buy on a whim, but don't underestimate that gut feeling either on occasions.

I once had a spread running on Sept S&P, thought I would nick a few points by shorting the same spread for half the long bet over the next few hours. Only to find that they sold half my long position for a bloody loss...I suppose it's there somewhere in the small print.

Now, I understand (with CMC) that if you opt to go long £10 per point, you cannot have a short position of say £5 per point running simultaneously (as this will effectively reduce your long position to £5 per point). I have, in the past had opposite trades running like that, however I use another account to do the trade, so in short it is possible but you must have 2 accounts.

Lastly, with most companies you can go long and short in different time frames example long rolling and short on say a month’s contract.

The hardest, HARDEST, thing is discipline to stick to what I have learnt about the market, and to not trade too big on any one thing, no matter how juicy it seems at the time. A small platoon of strong soldiers will get a job done well, so that's how I'm playing. The real live experience from Thomas below is deadly common -:

'I've been spreadbetting for about 6 months, and I was doing fairly well for the first 5 and a half months, using it as a way to 'invest' for the medium term by going long on futures. I was doing great with RBS, especially on the morning of their results, I was up to a net balance of £1,100 after starting with £500. Unfortunately I didn't close my positions and the share price plummeted over the next week, and I was down to only £150.

So I gave up on that and started betting on the daily FTSE, opening and closing a few positions a day. I got myself back up to £500, and thought I was doing well, until I took a little too much risk and had a really bad day which nearly wiped me out. A last throw of the dice on RBS last week and I am now totally wiped out.

I realised that I had started to think like a gambler, my losses hurt so much that I took too much risk to try to claw them back. So I have gone back to the drawing board, I am going to try a few systems using a demo account, and make sure I have one that seems to work well for me, before I dabble again. Also, I think a few months out of the market will do me good mentally.'

Chasing my losses - going long on FTSE Friday afternoon as it "must go up" (used my stop on this one though!).

Taking profits too early - went long as soon as SHIRES results came in but cashed in with 5 point profit (went up 30 before fading a bit).

Had a rolling spread bet on Yell (short ) which Finspreads closed last night @ 501p. Today they opened the start price @ 491p. Checked with them and they informed me that because Yell issued 10p dividend that the opening price had been dropped by 10p.. All this means that I start the day with 15 point drop from last nights close...(as it currently stands ). The lesson is check dividend dates.. Stupid boy !!!!

I learned that there is a world of difference between deciding to close a bet and actually getting it closed when there is heavy (panicked?) trading going on. Well, it wasn’t quite as bad as it might have been, but I have lost about half of my pot in a few days holding on to Soco (stock) watching the sands run out and then seeing it crashing down while I was trying to sell my 3k spread bet.

Took 20 minutes with lots of rejected trades as I find out they would only do 500 at a time no matter what volume's available in the market and they also reject the deal if the bid moves in your favour in the 30s it takes them to think about it (strangely they've no problem if it moves against you). I suppose I could have phoned - but I suspect it was a busy morning and I might well have been on hold for 20 minutes.

Had Soco gone to 0 I'd still be in the game, albeit with a blotted copybook as IG would have had to wait a week or so for a chunk of their money as I raised funds from the rest of the portfolio but I still felt I had something useful to communicate - at £15, £10 looked far off. But it wasn't. After a few precipitous drops with no stock specific reason whatsoever, £10 was concerningly close. If this happens just because the market's getting a bit jittery, what would happen if we actually had even minor bad news?

This was a very valuable learning experience about how even quite modest gearing can be very dangerous. For a valuation based approach, stop losses are a lunatic capital destroying concept. But if you choose to use leverage you have put yourself at the mercy of the market and have no choice whatsoever but to employ them. Your choice is just whether they are at the point of complete ruination or somewhere less painful but more likely to be triggered.

I'm afraid deciding ahead of time which way the market will go is another mistake. Trade what the market does and not what you think...Better wait until at least 9am to see the general state of the market before doing anything.

Carelessness

Not really a mistake but had my mouse on the buy button when FTSE was at its low on Friday but pulled out - it went up 20 points. Don't know why I'm telling you this but I guess my point is don't EVER take things for granted and once you have a plan STICK TO IT!

Also watch the units as £1 per point = 100 shares for companies. You can easily place order for tens of thousands without realizing. Also, you can trade the indices and sectors very easily with enormous values thanks to the minimum margin - used to be £50 for the FTSE or £100 for the Dow Jones. The DJIA spreadbet works in pounds not dollars so watch that too...

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