Risks of Trading Spreadbets

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.

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).

The managing director of Capital Spreads, the spread-betting division of LCG 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.

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