Spread Betting Education – Technical Analysis 16
Today we’re going to take a look at Spread Betting Education – what kind of materials are available to guide you when you open a spread betting account?
Spread Betting Education
Last week we finally opened a (demo) spread betting account with IG.
- The IG website has videos and Beginners’ Guides (explainer pages)
- The HL website provides an introductory booklet as well (HL use a white label version of the IG spread-betting service)
I promised to work my way through this so that we were ready to place our first best.
- Note that in the summary below, I’m going to assume that the reader is familiar with buying and selling stocks through an online platform
- I’m going to focus on the differences between a stock broking account and a spread betting account
So what’s in all this stuff? Broadly, we can split the material into five sections:
- sales pitches
- the facts about the service
- good practice “tips”
There’s a mix of the usual warnings that things you read on the web – or download from a website – don’t constitute investment advice.
- As with this website, it’s always your responsibility to do your own research (DYOR) and if you feel the need, to seek independent professional advice.
There are also spread-betting (SB) specific warnings to do with leverage:
- SB usually works on margin, where you use only a small percentage of the total trade value
- this means that if the trade goes wrong you could easily owe more money than your original deposit
- this is different from most investments, where all you can lose is the money you first invest
- if you do owe more than your deposit, then you would be asked to make another payment (this is a margin call)
- you can of course guard against this by using stop losses (see below)
- and you can deal with the psychological effects of leverage by always thinking in terms of the full value of a position, rather than the deposit margin you have paid
So the material makes it clear that SB is only suitable for “experienced and sophisticated investors”.
- I’m not sure that this is referring to the FCA’s definition of a sophisticated investor, which is based on income and / or net worth
- I’ll let you know when I convert my demo account into a live one
The documentation covers some of the advantages of spread betting, which we looked at last week:
- more markets and investment choices – commodities, FX, interest rates, sector indices etc.
- leverage (a double-edged sword, but potentially an advantage, since you don’t need all the capital up front)
- no commissions (the spread – between the bid price for you to sell at and the offer price for you to buy at – is the only cost)
- ability to go short (sell first and buy back later) and so to profit from falling prices
- no stamp duty or betting levy on trades
- no Capital Gains Tax on profits for UK residents (but also no offsetting of losses)
- this is because profits are classified as gambling winnings
- no need to declare your SB activity on your tax return
- simplicity – all you have to do to profit is predict the direction of the price movement over the time frame you have chosen (of course, if doing this was easy then all investment activity would be simple)
It also includes a pitch for the IG platform:
- stability – 99.95% uptime, which translates to around 20 minutes of downtime a month by my calculation
- tight spreads, deal-through charts, free live market news, customisable layout, live data and analysis of what other clients are trading
There’s also quite a bit about the mechanics of how to use the platform, which I won’t go into here in great detail
- it’s very similar to a regular stock broking platform, with a few changes to reflect the way that spread betting works
- Spread betting is a way of profiting from (or losing money on) market movements without owning the underlying assets in question.
- Spread betting is a replacement for other derivative products like options and CFDs.
- SB has taken over in the UK because of the favourable tax treatment (everybody thinks they will be a winner though surveys show that between 80% and 95% of spread-betters lose)
- in other countries, options and CFDs remain popular
- The price is “based on” the market price, rather than being simply part of a provider’s “book”.
- the bid price will always be below the market price, and the offer price will always be above the market price
- Providers make some of their money from the spread, and so are not always betting against you
- though unless you are a consistently winning better, they probably are betting against you rather than laying off your bets in the market
- Bets can be closed at any time that the market is open.
- for some markets, 24-hour dealing is offered
- Because of this – and unlike traditional betting on the horses – SB is not “win or lose everything”
- though because of many people’s preference for the old style of betting, there are now lots of financial “binary bets” as well
- we won’t consider these further here
- You don’t get the dividends if you hold SB contracts on shares though the price will usually be adjusted if the stock will go ex-dividend before your bet expires.
- You can short stocks (and indices, commodities etc.)
- a lot of people struggle with the concept of selling something that you don’t own
- but with spread betting you never own anything anyway, you’re just betting on which way the price will move
- so if you think the price will go down, sell first, then buy back at a lower price.
How to make a bet
Rather than buy a quantity of shares (or of an index etc.) you instead decide on a stake per point
- so for the FTSE-100 trading at 6150, you might choose £2 a point and buy (perhaps at 6151, allowing for the spread)
- if the FTSE closes at 6200 you’ve made 49 points x £2 = £98
- if the FTSE closes at 6100, you’ve lost 51 points x £2 = £102
Each market (underlying financial instrument) will have its own minimum bet size (£ per point)
The diagrams below show how things work:
There are also financing and margin costs to think about:
- these are essentially interest charges on money the provider is lending to you
- they are usually linked to LIBOR, the London Inter-Bank Offered Rate most famous for the recent rate-rigging scandal
- LIBOR is usually a little higher than the Bank of England base rate, and the financing rate for spread bets might be set at LIBOR + 2.5% (or LIBOR – 2.5% if you are short)
- overnight financing charges are less significant in a low-interest-rate environment like today’s
The traditional analogy to help understand how margin works is the mortgage on a house:
- if you have a £100K house and a £90K mortgage, then if house prices rise by £10K you’ve doubled your equity in the property (£10K to £20K)
- if you paid cash for the house, you’ve only increased your equity by 10% (£100K to £110K)
- this 10:1 ratio of multiplying gains is known as the gearing
- it’s important to note that if house prices went down by 10%, then you would suffer the same multiplier effect in reverse
- with a mortgage, you’ve lost all of your equity (£10K to £0K)
- paying with cash, you’ve only lost 10% of your equity (£100K to £90K)
Spread betting margin is just the same as the mortgage – you put down up to 10% of your actual position as cash, and the rest is a “mortgage”.
- if your deposit is 10% (ie. gearing of 10:1) and prices move 10% in your favour, you’ve doubled your money
- if prices move 10% against you, you’ve lost your deposit
Deposit margin percentages will vary by market and between brokers.
- More volatile markets will usually require higher margin deposits
- Equity margins are usually between 10% and 25%
- Positions with guaranteed stops have margin requirements equal to the risk on the bet
- Positions with non-guaranteed stops have a risk margin and a slippage margin
- The slippage margin caters for the possibility that the market will gap past your stop
- Slippage factors add another 30% (stocks) or 50% (FX) of the non-stopped margin
Different brokers have different rules on how much cash you need to hold in your account, and when they will make a margin call against you.
- Most providers like you to keep a positive balance to cover small price movements against you.
Every spread bet has a timeframe.
- you don’t need to keep the bet open for this length of time
- but the bet will be automatically closed after this period if you haven’t done so already
You can close a position at any time that the underlying market is open, and for some markets, 24-hour dealing is offered.
For a stock there are typically four time frames:
- DFB or Daily Funded Bets run as long as you like with a small charge each night if they are kept open
- DFB bets have the tightest initial spreads
- the next quarter day (end of the next calendar quarter – March, June, September, December)
- the quarter day after that one
- and the third quarter day in the future
Bets that expire on the quarter days have no overnight charge – the cost in included in the initial spread.
- Rollovers allow you to convert a bet which is near to its expiry date into the next contract period. The bet will be closed and then reopened (at a new price which includes the financing cost for the extension).
We’ve already mentioned stop losses, which get you out of a trade if the price moves against you.
- some providers allow trailing stops, which move up as the price moves in your favour
- some providers will allow guaranteed stop losses – here you pay a small premium to ensure that you get out at your intended price, even if the market moves quickly and “gaps” past you exit price
Another way to get out of a position is a limit order, which is actioned when the price hits a certain level
- limit orders can be used to open or to close a position (eg. if your profit target has been met)
Stops and limits are opposite types of order:
- a stop is an instruction to deal (close a position) at a less favourable price than now
- a limit is an instruction to deal (open or close a position) at a more favourable level than now
There are also two types of (limit and stop) order based around how long you want them to exist for:
- GFD or Good for the Day orders will expire at close of business
- some markets have “Good till a specified time” orders, rather than GFD
- GTC or Good Till Cancelled orders will still be there tomorrow
- Get to know the trading platform first by using a demo account.
- Only trade with money you can afford to lose.
- Never invest on a whim, but identify your target price for the underlying – know where you will get out.
- Always think in terms of the full value of a position, rather than the deposit margin you have paid.
- Never open a position without setting a Stop Loss to protect yourself.
- When a trade moves against you, cut your losses and look for other opportunities. Don’t move your Stop Loss further away in the hope that the price will recover.
That concludes the survey of the educational material from IG and Hargreaves Lansdown.
My other piece of homework from last week was to put together a watch list of the main markets that I plan to trade.
- I’m calling this my Stage 1 watch lilt – it will be restricted to indices, FX and commodities
Here’s my first attempt, with 18 markets:
There are eight indices, seven FX pairs and three commodities:
- FSTE-100 and FTSE-250 from the UK
- US 500, Russell 2000 and Tech 100 from the US
- one each from Europe, Japan and China
- the six cross-pairs between GBP, EUR, USD and JPY
- for fun, Bitcoin (presumably against the dollar)
- gold, oil (Brent) and copper
For now, they are all DFB markets.
Next week we’ll look at the charts for some of these markets, and hopefully work out whether we’d like to place any trades
- I expect that most of the time there will be no good trade in a particular market, but with 18 markets to choose from, there should be some trades most of the time
Until next time.