Spread Trading Guide

oAbyss or opportunity? Investors must decide which prospect beckons after a year of seismic shocks on both sides of the Atlantic. The credit and Sovereign debt issues, the raised profile of the markets and USA debt issues have undoubtedly brought more people in general to trading and spread betting in particular. Volatility is likely to mean opportunity for profit for many spread traders since they are able to make money on both up and down markets.

This spread trading guide aims to play a modest part in the ongoing and future growth of spreadbets – i.e., to provide a basic step-by-step ‘trading manual’ in explaining the workings of spreadbets. It will present the basic information about trading spreadbets as well as give you some tried and tested trading strategies that you can implement to help you making money trading spreadbets.

Spreadbets are leveraged derivative financial products. A derivative is practice a financial product whose value is derived from the value of another market. So, for instance, as opposed to investing directly in Tesco shares, you may put your money on the possibility that Tesco shares will move in a particular direction. And so you proceed to place a bet – which to all intents and purposes it is (which is why it is sometimes referred to as spread betting) – with a spread trading provider. Since spread trades are all about margins and leverage, you need to recognise that while any gains will be multiplied, any losses will be amplified as well.

UK spread betting firms quote bet prices on individual shares, stock-market sectors, indices, commodities and currencies. In a nutshell spreadbetting involves placing a trade on whether a specific market instrument will rise or fall in value and in relation to a quoted spread, which comprises bid and offer prices. The way it works is like this: you place a bet on a share or anything from gold to wheat or a foreign exchange pair rising or falling in value, without actually buying shares or the instrument. You out money on each point at say £10 a point of a rise or fall over a set spread. If you get your prediction right, you win but if your prediction proves wrong you can lose – and if you lose you can lose an amount exceeding your initial stake.

Explaining Spread Betting

I used to trade financial futures and options on liffe I also traded spreadbets and shares once liffe went screen based.

An example -:
If you buy shares you will also be charged brokerage and stamp duty (0.5%)
e.g. buy 1000 shares at £1 = £1000 + brokerage commission (say £10) + £50 = £1060
so if you only speculate £1000 and the stock moved 10% (big move) you would sell at £1.10 = £1100 – broker commission say £10 = £1090 = £30 profit.
Not really worth the risk is it?

You need some decent money to actively trade. Shares you cannot go short i.e. bet on them going down, unless you borrow the stock first. Spread bets are in effect synthetic shares. You can buy or sell and can gear up too but are more risky.

Speculations are required to place an initial deposit on the share, which may likely be from 5% to 10% for FTSE 100 blue chip companies. Traders should however be aware that they are still liable for the full capital value of their holdings. This means that you will have to make good any losses on your spread betting account in full…

You can open an account for £2k. But you can gear up which means you can buy/sell more shares as you only pay a margin therefore can buy much more than £2k worth of shares. Risk is you can lose more than your £2k.

Because this is spread trading, I’m setting a price per point that I expect the stock to move. At £20 a point, if Barclays shares fall 50 points I’m up £1000. If they gain 50 points, I’m down the same.

In the last decade there has been a sharp upsurge in spread trading, which have tax and cost advantages over conventional share dealing. They also provide speculators with leverage, which means if the market you are betting on goes up you win big. It also means if the market you are betting on goes down the losses are punitive. Here it is also worth noting that with any traditional stock transaction purchase you have to incur stamp duty at 0.5% and you will be taxed on your capital gains. With most traditional investors and private investors benefiting from stock trading and more providers entering the markets offering increasingly tighter spreads it is only a matter of time for the level of spread trading to attract even more interest and awareness amongst the general public.

Before you start spread trading for real money it is recommended that you do some paper trading. Most spread betting providers nowadays will offer demo account facilities. To start spread trading, you will need to deposit some monies into a margin account. The amount is actually the deposit you will need to open a spread trade. If you have £5,000 in your spread betting account and the broker has a minimum margin requirement of 1%, then you can trade up to 100 times your initial investment; i.e. open positions of total exposure of £500,000. This may sound great but keep in min that the lower the margin you pay, the more the profit/loss will be magnified even with very small price movements. You need to have sufficient unencumbered funds in your spread trading account to meet your margin requirement should the trade move against you.

Margins tend to be higher for individual stocks, especially if they are less liquid, than for forex and commodities. The amount of leverage offered will depend on the spread trading market. Generally for shares this might be 5 to 10% while it would be as low as 1 per cent for foreign exchange pairs.

Be careful because the spreads can be quite wide on illiquid shares and you are down as soon as you make a trade because of the bid-offer spread.

Spread Trading

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