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Spread betting is risky, but it can also help to minimise risk if used properly.

ONCE you're getting tips from the shoe-shine boy, it's time to take cover.

That's one of the great axioms of financial speculation - as the theory goes that if even the guy buffing your brogues is playing the markets, then they have been overbought.

Yet, for all the new accounts opened by traders, financial spread betting companies now claim to have similar numbers of dentists and taxi drivers signing up as well. So how do these new spread punters protect themselves? And, despite its risky nature, can spread betting actually be used to minimise risk? Stop! "A STOP loss is the most important [risk management tool]," says Cantor Index's David Buik. "Also, remember not to bet too often, don't bet more than you can afford and don't bet on what you don't understand. Make sure you're well-read, well-informed and know the product." A stop loss is an advanced order with your spread betting company telling them to close your position once your losses reach a certain point.

So if you bought Vodafone shares at 130p for pounds 10 a point, on the assumption that you did not want to lose any more than pounds 100 if the trade went wrong, you would set your stop loss at 120p (so the most you can lose is 10 points at pounds 10 a point).

However, while a stop loss will mostly ensure losses in this example do not exceed pounds 100, it will not guarantee it.

If, for example, bad news comes out overnight, and Vodafone shares open the following morning at 115p (below your stop of 120p), your position will be closed at 115p. You may be relieved you got that price if the shares continue to fall, or you may start to regret not taking another more secure option - the guaranteed stop - which you could have fixed at 120p (for a fee).

Risk management IF this seems overly complicated, then fret not. Most spread betting companies run educational programmes so that punters can learn about the risks involved. In IG Index's package of online seminars, there is one called 'Risk Management Using Stops' - which can be accessed free via the company's website - and explores the use of stops, and guaranteed stops to suit particular styles of trading.

Elsewhere, at City Index, all accounts have a dedicated assigned account manager, who can help clients with education, market information, depositing funds and up-to-date market news.

These avenues will provide punters with plenty of tips on how to manage - and reduce - risk, but the best advice you might get could be listening to another of those old investment cliches.

It was in the cult 1987 film, Wall Street, that the hero Bud Fox told the film's star character, Gordon Gekko: " You once told me, don't get emotional about stock. Don't! The bid is 16 1 / 2 and going down. As your broker, I advise you to take it." It turns out that this is excellent risk management advice. Of all the skills to learn in financial speculation, taking losses is probably the hardest because - just like Gekko - we do get emotional about prices.

"It's important to learn how to take losses," says one seasoned financial punter. "It can be painful to sell below the price you bought at, or the price we could have sold at a few weeks ago, and in those circumstances we all imagine how our trade will return to profit. But it is important to know how to ruthlessly cut your losses when you've got things wrong and move on to the next trade." Increasingly, financial punters are getting less emotional by using tools such as technical analysis (TA) to determine stop loss levels.

Technical analysis is a method of forecasting the future direction of share prices by examining past market data and trends. Purists will consider only the price and volume of the market and employ models and trading rules - such as the relative strength index, moving averages and chart patterns - to determine how they will trade.

"Technical analysis is 100 per cent on the rise," says Joshua Raymond, a market strategist at City Index. "There is a much higher take-up of this kind of thing now than there was just two to three years ago." Hedge HOWEVER, despite stop losses, sometimes you cannot easily get rid of a huge investment exposure. For example, you may have just bought yourself a buy-to-let property, or have share options with your employer. In the recessionary environment, you could easily be concerned about those positions.

If you are, then hedging using spread betting is fairly simple - if not necessarily for everybody.

For example, if you are worried that the value of your illiquid investment may fall, you can take the opposite position, by shorting the equivalent bet for a particular period.

So for your share options, that might mean making a spread-bet that your company's shares will fall (just don't tell the boss). For your investment property, you might choose to bet that the appropriate housing index will drop, so that whichever way the prices move, you profit on one position and lose on the other. (However, in these examples, if you go short and the market rises, you will end up owing cash to your spread betting provider while sitting on paper gains).

Spread betting groups offer bets on the average house price for the UK as a whole as well as for London. You simply 'buy' the market - which is based on the Halifax House Price Survey produced by HBOS - if you think the average price is set to rise or 'sell' if you think it will fall.

"Hedging is a good policy to protect yourself but, to be honest, you don't see much hedging in spread betting," says Raymond. "Most clients are looking to place short-term trades and most spread betters are looking to make the maximum from the minimum." Still, for some punters hedging their exposure does appeal. Spread betting groups are reporting that traders are increasingly betting on commodities to hedge against the chance of increasing inflation as the economy recovers and quantitative easing kicks in. In fact, some firms reckon that bets on rising commodity prices are now at their highest levels for 12 months.

Hard assets - such as oil - provide some cover against inflation as they become more valuable as inflation goes up. Alternatively, the bond markets might also provide opportunities for punters looking to bet on future inflation.

Tim Hughes, head of sales trading at IG Index, adds: " As the inflation/ deflation argument yo-yos, the bond markets reflect enormous potential. The downside is that these markets are often a mystery to new spread bettors, but they offer the best access to the inflation and rates expectation issue." "Alternatively, a cruder proxy, if you excuse the pun, is the oil market.

Insofar as inflation (or deflation) is strongly correlated with the oil price, it is a high dollar value per barrel that holds inflation expectations, and therefore interest rate expectations, in positive territory at the moment." Other innovative hedges are also being developed by individual punters to suit their own circumstances.

"I've been looking at hedging my petrol price bill by betting on the oil price," says one experienced financial punter. "When oil was $150 a barrel, petrol was 31.20 a litre and that cost me a hell of a lot more each year in fuel bills. So I'm looking at going long of oil at $70 so if the price doubles again and petrol rises at the pumps back towards pounds 1.20 a litre, then I have offset this extra cost with the winnings from my spread bet. It involves a bit of a calculation to determine the stake size, but if the price of oil goes down, so will the price of petrol, and I'll be protected." Safety in pairs ELSEWHERE, other financial spread bettors are starting to use hedging techniques that have long been used by professional traders to minimise risk in certain situations. One such method is the so-called pairs trade.

Pairs trades were developed in the late 1980s by quantitative analysts and help hedge sector - and market risk. Certain securities, often competitors in one sector, are frequently correlated in their day-to-day price movements. But sometimes that correlation breaks down as one stock trades up while the other trades down. This presents an opportunity to sell the outperforming stock and buy the underperforming one - essentially a bet that the performance will revert to the mean and the 'spread' between the two will eventually converge.

For example, the FTSE 100 has underperformed the FTSE 250, so a punter might go long of the 100 and short of the 250. The market then crashes. Both indices plummet, but the punter wins on the short 250 position and loses on the long 100 bet. But if, as predicted, the FTSE 100 held up better than the 250, the bet has still been profitable despite the huge swing. This is because pairs trading is about making bets on stocks and indices relative to each other, rather than in absolute terms.

However, even though using risk management techniques such as hedging and stop losses - while being well-informed, only staking what you can afford to lose and attending numerous spread betting seminars - will undoubtedly help lower your risk when trading the financial markets, financial spread betting will always contain its hazards.

Like all forms of betting, there is little substitute for calling things right..'Of all the skills to learn in financial speculation, taking losses is probably the hardest because - like Gordon Gekko in the film Wall Street - we do get emotional about prices'

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Spread betting has become accessible to all, but will always contain its hazards
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Title Annotation:Sports
Publication:The Racing Post (London, England)
Date:Jun 20, 2009
Words:1624
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