Spread Betting the FTSE 100: How to Trade the FTSE

As one would expect the FTSE 100 is the most popular spread betting index to bet on, not least because most spread traders are located in the United Kingdom and more likely to be familiar with this benchmark than other markets. In any case the UK 100 is a good market when you start, it is one market you can track in the local headlines and it’s 24-hour. Usually you can take a spread trade on the FTSE 100 for as little as £1 a point and the market trades from Sunday night all the way to Friday evening.

This article is intended to be a 10 minute introduction to trading the FTSE. We’ll talk about what the index is, what stocks and sectors it is composed of and some of the things you need to look out for when trading it.

Starting with the basics, the FTSE 100 is an index (or “basket”) of shares from 100 of the largest companies traded on the London Stock Exchange.  The value of the FTSE 100 goes up and down with the value of its shares. Hence the index is used as an indicator that shows how UK companies (and to a limited extent the wider UK economy) is performing.

Trading the FTSE

But what is the FTSE 100? The FTSE 100 market consists of an index that is constituted of the 100 largest listed companies in the United Kingdom by market capitalization. All these companies are listed on the London Stock Exchange.  However you should note that the FTSE is a Market-Cap weighted average – so the share price of large companies such as BP and Vodafone will have a bigger impact than those of smaller ones such as Cadbury or ICI.

Market capitalization refers to how big or small is a company and is calculated by multiplying the number of stocks in issue by the prevailing share price.

Spread traders trade in pips and as such moves in indices are substantially amplified. As such even a 50-point, or 1% move in the FTSE 100 index can generate big returns.

Trading the FTSE 100 by Alastair McCaig of IG Index

A Quick Bit Of History

The FTSE 100 was launched on the 3rd January 1984 with a starting value of 1,000. Since then the make-up of the index has changed enormously – mergers and bankruptcies have meant the index only has 21 of the original constituents are left in it. The largest of the survivors is BP, although a fair number of constituents have changed their names too. Do you remember Commercial Union (now Aviva) or British Gas (now BG Group and Centrica)?

The FTSE index today makes up about 81% of the value of all companies listed on the LSE thus rendering it a good barometer of the state of UK business. To effectively trade or place spread bets on the FTSE 100 you first need to understand what makes the FTSE move.

Changes In The Constituents

The process for reviewing the constituents in the index is straightforward. All companies listed on the LSE are ranked in order of their market capitalisation. A committee made up of independent market experts meets in March, June, September and December and considers which companies should be allowed into the FTSE 100 and which should be dropped.

Changes in constituents can move the price of the individual shares, but probably won’t affect the overall price of the FTSE much. However they are still worth watching out for as it helps to understand the index you are trading.

It is important to note that the FTSE is heavily exposed to mining shares so you have to keep an eye on that particular sector.

What To Watch Out For When Trading

A massive range of factors can push the FTSE price up or down – but they tend to fall into the following categories:

  • Interest rate news: most Bank Of England interest rate changes are well-flagged, but the monthly interest rate meetings (usually at 12pm on a Thursday near the beginning of the month) are still worth watching out for. So too are the minutes from these minutes, which are published on a Wednesday morning two weeks after the meeting. These can give clues as to when the next interest rate change might be, and what might be happening with other Bank Of England activities (such as Quantitative Easing).
  • Economic Indicators: almost any economic indicator has the potential to surprise and hence to move the markets. Some of the most influential ones are the Purchasing Manager’s Indices, Consumer Confidence Indices, Unemployment Figures (claimant count), GDP and Price Indices (such as CPI and PPI).
  • Individual company news: this will directly affect that company and, quite often, the company’s peers. So the impact of the news will, of course, depend on the importance of that news item and the size of the company(s) spread bet trading calendarit relates to. News items, by their nature, are unpredictable. However pay special attention to times when news about a company is likely to occur – e.g. around the times when a companies results are due out.
  • Technical Adjustments: many shares in the FTSE 100 pay dividends, and in doing so they transfer some of their wealth from their bank account into that of their customers. Hence their value falls, their share price falls and consequently the value of the FTSE will fall. Trading FTSE when shares go ex-div When several of the shares go ‘ex-div’ on the same day, this can have a significant impact. For example on the 5th May 2010 several FTSE 100 stocks went ex-div (including BP, Shell and Glaxo Smith Kline) overnight, knocking 18 points off the FTSE at open the next morning. If you have a position open while stocks are going ex-div, the results will be broadly neutral. A long position, for example, will suffer from the value of the FTSE falling but there will be a corresponding dividend adjustment paid into your account. Similarly those holding a short position will benefit from the fall in the FTSE price but will see a dividend payment leaving their account. However do look out for your stop loss orders and profit orders. If these orders are coming close to being executed, a dividend payment overnight may just cause them to be executed.

Commodity price changes have a larger effect on the FTSE 100 than the Dow, the DAX and most other indices. This is because commodity related equities constitute 30% of the Footsie and as such the index is more likely to benefit from a strong Chinese economy with its huge appetite for resources.

Know Your Index

A common misconception that the FTSE 100 is a pure representative of the UK economy. This simply isn’t true; research from Citibank shows that around 75% of the revenues of FTSE 100 companies came from outside the UK. Even more surprisingly, most of the top 10 FTSE 100 companies report their results in US Dollars rather than Sterling. The largest company in the FTSE 100 that could properly be described as a British is Tesco, and even the supermarket behemoth is increasingly exposed to international markets.

In the past the FTSE 100 might have been a good way to play a UK recovery but this is simply no longer true; the index is today dominated by global commodities and financial services enterprises, whose earnings are predominantly international in nature. So the FTSE 100 isn’t UK Plc – rather I view it as a global index with a bias towards UK companies. For example the FTSE 100 currently has 11 miners in it; all of their share price are hugely affected by what goes on in China. Also five oil companies (including BP and Shell) call the FTSE 100 home despite their share prices being more heavily affected by events in Riyadh than London. Those two industries alone make up around 30% of the index – so commodity price changes have a larger effect on the FTSE 100 than the Dow, the DAX and most other indices.

My point here is that when trading the FTSE 100 you need to keep an eye on what is driving the larger underlying components. It’s completely possible that if you get a small improvement in the unemployment rates but a simultaneous fall in Brent Crude Oil then the FTSE 100 may actually fall.

FTSE themselves publish a handy factsheet on the FTSE every quarter (http://www.ftse.com/Indices/UK_Indices/Downloads/FTSE_100_Index_Factsheet.pdf), which shows the 10 largest companies by market cap and which sectors have the largest market cap in the index.

The FTSE 100 consists of 100 companies, of which 10 make up about 45 per cent of the index value. The German Dax consists of 30 stocks, representing the creme-de-la-creme of German commerce and industry. Together, they are considered the two leading stock indices in Europe.

I realised that there is a statistical correlation between the two stock indices significant enough to bet on. I began to explore how to trade the two against each other in a straight arbitrage strategy, and came up with the idea that if the two diverged by more than 40 points from the previous night’s close, I should short the one that was strong, and buy the one that was weak.

Why the FTSE?

Good question as there are so many other things to trade, and the trade setups that we take do apply to other markets, but some traders find Indexes easier to trader compared to Forex. Its Forex that gets all the attention, most of the flashy ‘Get Rich Quick’ systems that don’t really work are targeted at that market with the get rich quick by trading $10 million worth of currency with a few thousand in your account angle which should really read lets take your money as quick as we can!

What most people don’t get about Forex is that the big banks are in control of the market, they know where all there customers stops are they can drive the price around and take all the money and they do, not that is a bad thing as they are free to do that, its just the time it takes the average home trader to work this out means its probably costing them there trading account or 2. If you take time to work it all out then yes you can do really well out of Forex pip for pip def more than the Indexes, but the learning period is def longer and harder as you have to develop a six sense as to what the big banks are up 2. You also need (and this is where most new trades blow even more money) to know about cross currency analysis and yes once you understand how that works you can make money. 3 out of the 4 world class traders, that I learnt from traded Forex so I am not saying don’t I am just staying in my mind Indexes are easier to learn and yes a bit less manipulated by the banks and the trading companies. Forex traders at the main banks have to trade at what ever price they want to quote they cant simply say ‘I don’t fancy a trade at the moment’ were as with stocks there are people wanting to buy and others that want to sell, and its only when they both agree does the transaction take place and the price moves.

The other advantage you have with Indexes is that there is really simple cross analysis to confirm trades or not, in the UK market you simply want to see the FTSE, DOW and DAX all confirming the same move, its as simple as that, if the FTSE looking good for a long, but the DOW against resistance or showing short = no trade.

But what’s more important is to study, learn and trade one thing; you get a feel for what’s going on, what reaction of that instrument to news, what the key levels are. It is my thought that this offers the new trader the best chance of learning trading basics and then yes once you learn your own rules you can trade anything you like.

Spread Betting the FTSE 100: Practicalities

The FTSE index benchmark can be stagnant for months moving in a range of maybe 40 or 50 points but in turbulent market conditions it can move by over 200 points in a single trading session. You can spread bet the FTSE using either the daily rolling bets or futures. Daily bets are more suitable for short-term trades and comes with very tight spreads – typically at just 1 point. As the name suggests daily rolling bets can be rolled over from one trading day to the next, subject to a small financing charge each time this happens. Longer term trading views can be taken using the quarterly stock index futures. The spread for futures is wider but these contracts do not incur daily financing charges. Initial margins usually work out to around 40 times the stake for both FTSE daily bets and futures.

A £1 point bet stake on the FTSE 100 would translate into an effective exposure of £5,500 (with the FTSE at 5,500). If you are considering a medium or long term trade you will need to utilise fairly wide stops to take account of the day-to-day market fluctuations.

Dividend Adjustments

The day before I placed a trade with IG Index £5 short on the FTSE 100. I noted that at about 4.30, £126 were debited from my account. When I called IG I was informed that this was the dividend adjustment which is made every Tuesday. The adjustment took 25 points out of the FTSE.

This is normal and there is no net effect on your position. The FTSE price is marked down by 25 points netting you 25 x stake “profit” while 25 is debited from your trading account to offset this giving you 25 x stake “loss” = neutral effect. i.e. your trade will show an additional £126 gain due to the dividends that have been taken out of the index price while your cash balance is debited by £126. Obviously this results in a realised loss but the cash adjustment itself has no effect on your profits/losses of your trading account.

Naturally if your spread betting provider didn’t make any such adjustments all you would need to do would be to short the market the day preceding the dividend distribution day and buy it back the next day i.e. free money which doesn’t exit in the stock market!.

Spread Betting the FTSE 100 (UK 100): Example

The FTSE 100 is the single most traded instrument at many spread trading companies. Why? One of the main reasons is the tight spread. Trade with Capital Spreads and the FTSE Rolling Daily spread is just 1 point; on a market that can easily move 100 points in a day that is tiny.

However price is not the only advantage the FTSE offers. Consider:

  • it trades during the European working day – so no need to become a night owl
  • it moves enough (i.e. is sufficiently volatile) to create plenty of opportunities news and opinions about the FTSE are fairly accessible

The UK 100, or “footsie”, is one of the most familiar indices for most spread betters. When the markets are open, if you have a variable spread betting provider, you will find some of the smallest spreads on this index.

How Is The FTSE Rolling Daily Price Calculated?

FTSE calculate the FTSE 100 price every 15 seconds from 8am to 4.30pm. However 15 seconds is too slow for trading, so providers normally base their FTSE Rolling Daily price on the FTSE Futures contract which trades on the NYSE Euronext (formerly LIFFE) exchange. Only quarterly contracts are traded on this exchange, so providers take the nearest contract, make certain adjustments (for dividends and “Fair Value”) and publish that price. The result is an instrument that can update several times a second and can be traded nearly 24 hours a day.

Say that your spread betting company is quoting 5491.5 – 5493.5. You think that the FTSE will be going up, so you take a daily rolling bet for £4 per point that the index will increase. When it reaches 5562.3 – 5564.3 you decided to collect your winnings, so you close your bet.

To work out how much you have won, you must figure out the point difference that you have gained. Your initial bet was at 5493.5, as the higher number is the buying price. When you closed your bet it was at the selling price of 5562.3.

That means the total number of points you gained was 5562.3 less 5493.5. This works out to 68.8 points.

Your bet was for £4 per point, so the amount you have won is £4 times 68.8, which is £275.20.

It’s quite possible that your bet did not win. Some successful betters even lose more often than they win, but make a profit because they make sure when they lose they close the bet and cut their losses quickly. Say that instead of going up the FTSE went down and you decide to close the bet at 5473.2 – 5475.2.

That means you open the bet at 5492.5, and closed the bet at 5473.2. Your total losses were 5492.5-5473.2, which is 19.3 points. For your initial stake of £4, that amounts to a cash loss of 4×19.3, which is £77.20.

For Longer Term Traders

So far I’ve been assuming you want to trade the FTSE Rolling Daily – the most popular market on most providers by far. However that may not be the case. If you are looking to hold your position open for a few weeks or event months, I suggest you look at thequarterly contracts – available from the Indices – Capital Spreads UK Indices screen. The quarterly contracts, which expire in March, June, September and December have a slightly wider spread but they do not have a financing charge so – if you are planning on holding a long position open for a while, they may work out more cost-effective.

Example: Assume now that you want to take a view on a futures spread trade. The quote you get for a spread bet finishing in three months time is 5466.5 – 5476.5. You decide that the index will be going up over the long-term, and stake £8 per point on the UK 100.

Although this is a long-term futures bet, you can close it at any time, and you choose to cash in the next week, when the index has shot up to 5682.1 – 5692.1.

As this was a “long” bet, your starting level was 5476.5, and you closed at 5682.1. That means you gained a total of 205.6 points. You placed a bet of £8 per point. To find your total winnings, you must multiply the points change by the stake, that is 205.6 times £8. Your total gain on this spread bet is £1644.80.

Once again, you might not have been so lucky or skilled, and the index might have fallen. In this case say it dropped to 5438.2 – 5448.2 before you decided to cut your losses and finished the bet. The starting value was the same as before, 5476.5, and you closed out at 5438.2. This means that the index fell 38.3 points against you. The bet was still £8 per point, so you multiply these together to find out what you lost.

£8 times 38.3 points amounts to £306.40, and that is a total that you lost on this bet.

Trading Strategies For The FTSE

I’ve deliberately steered away from recommending any trading strategies in this piece, as it is such a large topic. However most traders and investors I’ve met trade using either one or a combination of the following:

  • Developing a macro-economic opinion: if you feel you have a good grip on what is happening in the UK and global economies then a spread betting account with a provider will let you trade your views. To keep your views up to date you’ll need to spend a lot of time watching the news
  • Using the charts: there are whole host of trading strategies you can use for the FTSE. However, if you want a personal opinion or just need somewhere to start with your demo trading, I’m happy to say that I’ve had my best sucesses with simple trend-following strategies, supported with Moving Averages. In fact I am frequently suprised by how often the ‘trading gurus’ market complicated ‘methodologies’ that are variants of trend-following.
  • Promotion and Relegation: one other way traders could take advantage of more short-term events is through the quarterly rebalancing of the index. Relegation from and promotion to an index normally results in significant movement of the buying and selling stocks. Index-tracking funds, part-passive funds and exchange traded funds will have a limited window in which to dump a stock if it is relegated from an index as these funds will be expected to hold a basket which accurately reflects the index.

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