Financial spread betting can, and does, provide many opportunities, and used correctly is an excellent trading tool for both speculation and also hedging, but most people fail to understand the basics ( or what I consider to be the basics) and start by learning how to place a trade or spread bet, which to me is the easy part, which we are going to cover now, with some worked examples. Trust me, you have covered the most difficult part, the rest is relatively easy. Now once I’ve explained how to place trades and how you manage open positions, we then need to look at how you manage your risk, decide on the size of positions, trading plans, using spreads to hedge and comparing spread betting with trading the futures markets ( lots more to explain I’m afraid!) So, let’s start with a couple of simple examples which I’m sure will make everything very clear, as the principles of spread betting are actually very simple, but it it is the underlying complexities of the financial derivatives markets and margin accounts that make online spread betting so dangerous.
As most of us are familiar with buying a stock or share and making a profit from the asset rising in value let me start with something familiar and a share on the London Stock Exchange in the FTSE 100 – Tesco, a solid defensive stock with low volatility. It is October and the price in the cash market is 318p per share. Now we are considering a long term trade, and feel that the share is due to rise, and therefore look for the next available contract ( the front month remember) which in this case is December, so here we are trading a spread on the futures contract. We check online in our spread betting account and see that the company is currently quoting a spread bet of 318 – 321. The spread bet quoted has two elements namely the bid, and the ask ( sometimes called the offer). The bid is the lower of the two prices, so in this case is 318, and the ask is the higher of the spread at 321. The bid is the price you sell at, and the ask is the price you buy at – the easy way to remember is ” go high to buy”. So we always buy at the higher price and sell at the lower price.
Now as this is our first financial spread bet, we choose the lowest unit amount to bet, and find that the minimum is £2 per unit, which in this case will be a 1p movement in the share price ( remember, that the minimum unit will be quoted in the market data sheet). Whilst this may seem a small amount to you at the moment, just remember that this is equivalent to you buying 200 shares in Tesco ( 200 x 1p) but only requiring a margin deposit of perhaps 10% to open the same position with the spread betting company. This is the power and danger of margin trading that we covered earlier. If you were to open the identical trade in a traditional cash account with an online broker, you would need to have a minimum cash balance of 200 x £3.21 or £642 – with your spread betting account you will only need perhaps £64.20. I know you must be bored hearing me say the same thing over and over again, but just step back and think what you are doing when trading in spread betting. The position you hold in the market will be identical betting £2 per 1p movement with a spread betting company, as holding 200 shares with an online broker. Please keep this in mind at all times! So we think Tesco plc is due to rise over the next few weeks, and we are therefore going long on the December Tesco Futures contract currently quoted at 318 – 321, knowing that this will not expire until well into December, and we may decide to roll it over at that point. We therefore buy the contract at 321 ( go high to buy) at £2 per point and the contract is open!! ( easy as that).
It is now early December and we have been holding our spread bet contract for 6 weeks. We were right to go long as the market rallied, and in addition Tesco announced some excellent results exceeding market forecasts, and the share price duly rose to 376p per share. The Tesco December Futures contract is now being quoted at 375 – 378, and we decide we would like to close our trade and take our profit. We could of course leave it to expire on the final trading day, which is always an alternative option, if you feel that your position may improve still further. However, in this case let’s assume we have decided to close out before expiry. Now in order to close any open trade, we have to enter an opposite order to the one we entered to open the trade, so in this case we opened with a “buy” order, and so to close we need to place a “sell” order ( this can be confusing for the new trader, but you must get used to this method – just remember you do the opposite to close a trade). Now when you close your position, you must sell the correct contract, and for the correct amount, so in this case we are selling the December Tesco Futures contract at £2 (if you make a mistake and sell at a different price, or a different contract, you will be opening another position, and NOT closing the existing one!!) So we now sell at the lower price in the spread at 375, and at £2 per point, and we have now closed our position. So how much profit have we made – the figures will look like this :
December Tesco plc – Opening Trade: bought at 321
December Tesco plc – Closing Trade: sold at 375
As we can see from the above we bought at 321, and sold at 375, a total of 375-321 = 54 units. Now each unit is worth our bet stake which was £2, so in this case our gross profit is £2 x 54 = £108, less any interest charges. So that was our first simple financial spread bet – now let’s look at making money when prices are falling, and this is where financial spread betting really comes into its own!