Managing your Risks

Spread trading accounts are suitable for more sophisticated investors (i.e. experienced ones) and those who are willing to risk the occasional big hit in the hope of making greater profits further down the line. This method of trading is probably not for the light of pocket and in the past used to be the exclusive of rich banker types and others who were prepared to lose big as well as win big. But the internet has changed this and now spread betting is very popular with retail speculators.

Trading via spread bets is executed on margin which means that you can gain substantial leverage over the movements of an underlying market with a small capital outlay.  This amplifies potential profits but also increases the risks.  Because of this margin trading requires a specific frame of mind and discipline in the execution of orders and trades.  The ability of trading on margin is one of the main attractions of spread betting but it comes with a downside.  Should the markets move against your positions, you can lose an amount in excess of your deposited funds.  Because of this it is important to appreciate the potential for losses when dealing with margined products and in particular to avoid trading with money that one can’t afford to lose.

Know your Limits

It’s a critical aspect of smart spread betting: know your limits. Know how much you are willing to risk on each trade; how to set your leverage ratio in accordance with your needs and expectations, keeping in mind that leverage can both help and hurt you, and never risk more than you can afford to lose. Learn to manage the size of your positions and how much leverage to use based on your trading goals. And always make sure you have enough capital to trade another day.

Make sure to do some money management and risk management planning before executing trades.  Both elements are essential to successful trading and although sensible money and good risk management techniques won’t by themselves guarantee success, planning your trades properly by utilising stops and careful use of leverage will put you in control.  This is particularly important when day trading and/or dealing in fast moving markets.

Once you have worked out the amount you are willing to put at risk, the next thing is to learn to manage it properly by dividing this into amounts you are willing to risk per trade.  This will depend on the markets you wish to deal in and your style of trading.  For example, are you looking to day trade or position trade?  Do you intend to focus on trading foreign exchange (low margins) or individual equities which normally require higher margins to open positions?  Many professionals seem to agree that you shouldn’t risk more than 2% of your pot on any one trade and some even say this is still too high (of course others say you should risk more).  However, let’s assume that you create an account with £7,000.  Sticking to the 2% rule permits you to risk £140 per trade.  This limits the instruments you are able to deal in but allows you to trade thru 50 consecutive losing trades.  If you opt to risk 10% of your capital risking up to £700 this will permit you 10 losing trades.  However, £700 will allow you to deal in many of the financial markets available with your provider.

Most experienced traders are happy to make money on 50% of their trades since they utilise disciplined risk management techniques to ensure they make more money on their successful trades than their losing ones.  This helps them to succeed in the long run.  Before the placement of a trade, they have a good idea of how much they are willing to risk and of their entry and exit levels; including profit targets and where they will place their stop loss in case the market moves against the direction of their trade.  A trading plan like this help to eliminate the emotional pitfalls of trading and ensure that you don’t enter a trade if the risk-reward ratio is not favourable – i.e. risking  £200 to make £50, as opposed to  £600.

Spread Bets versus Shares

Spread bets are riskier than conventional share traders because you can trade on margin, which can magnify your losses as well as your profits – and potentially cause you to lose more than your initial deposit. In fact if you place a ‘sell’ bet to profit from falling prices, but the underlying asset keeps rising in price, your losses are theoretically unlimited.

What the Risks Are

Spread betting simply magnifies the risk of ordinary trading many times over because of the gearing aspect. But it also releases your capital and has other advantages. Just as people lose their houses because of pokie problems, they also lose their houses through poor share trading or spread trading. But the core problem is people not understanding risk. Before you start spread trading, it is extremely important you understand the high level of risk when financial spread betting.

Here, it is important to understand that the initial margin that you deposit with your provider to open a position doesn’t constitute your market exposure. In order to open positions you must have sufficient funds in your spread trading account to cover the notional trading requirement. However, if a trade were to move against you the spread trading company can ask you to deposit more cash and this is sometimes referred to as a ‘margin call’.

The potential for large gains must be balanced alongside sensible risk management and a solid risk-management strategy – for example using guaranteed stop losses – can minimise this.

Financial markets fluctuate in value throughout the day and at times these movements can be unpredictable due to uncertainty in the markets. It’s possible to control the exposure to risk and limit your liability to loss by using a range of risk management tools:

Stop and limit orders can help manage risk and protect potential spread bet profits by helping you get in or out of the market at specified prices. Stop losses are instructions to close a bet if the price moves too far in the wrong direction. For example, if you place a buy bet on the FTSE 100 at 5700-5702, you could place a stop loss at 5500 to sell if the price hits that level, to limit your loss to 202 points.

Controlled risk bet – sometimes referred to as a guaranteed stop. This lets you specify the level you want your bet to be closed at, should the market move against you. Guaranteed stop losses are instructions to close a bet even if the price jumps, or ‘gaps’ past your stop loss level. For example, if the FTSE 100 price jumps from 5501 to 5498, a guaranteed stop loss will still close your bet at 5500.

Stop loss order – can be used to limit your trading risk and lock in profit.

Limit Order – allows you to pre-determine a price higher than the current price at which you wish to sell, or a level below the current price at which you wish to buy.

One cancels the other order (OCO) – is a combination of both a limit and a stop and is useful for those wishing to get in and out of the market without having to watch it constantly.

Some providers will allow you to place trailing stops, which trail your position at a specific distance as it moves, helping to protect any profits should the market reverse.

Spread betting involves high risks, with the potential for substantial losses and is not suitable for all persons. The high degree of leverage can work against you as well as for you. Past performance is not necessarily indicative of future results.

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