Chapter 16. Risks of Spread Betting

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With the opportunities that come with spread betting comes risk. For those who ask, “Is spread betting gambling?” – the answer is “No”. 

But that doesn’t mean that there’s no risk of losing money.

One of the most important factors in putting together a good spread betting game, one that will generate profits for you, is practising careful risk management.

There are risks to engaging in any sort of business. Here’s a rundown on the primary risks to be aware of in financial spread betting. For an detailed look at trading risk you should consider taking our free course:

The risk of trading with high leverage

Financial spread betting is highly leveraged.

While this offers the major advantage that it gives you the opportunity to make a lot of money with just a small amount of starting capital, it also involves risk. Many traders not familiar with leveraged trading take on positions too large and, as a result, unfortunately, end up losing money rapidly.

Be sure that you fully understand leveraged trading before risking real money spread betting the financial markets.

For example
You might place a spread bet that only requires a margin deposit of 10% of the full value of the financial asset that you’re betting on.

If the price of the asset moves by 20% in your favour, then you will have doubled your money! However, should the asset’s price move 20% against your bet position, you will have lost double your margin deposit.

Leverage can be a critical advantage for you, but you also have to be aware of the potential risk for loss that it poses. In trading with high leverage, it’s important to make certain that you have sufficient trading capital to hold any spread bet position that you take.

Otherwise, you risk having bets closed out because your account doesn’t have enough funds in it to hold the position in the event that the market moves temporarily, but significantly, against your bet position.

Read: Situations When You Shouldn’t Trade Forex

The risk of market/price volatility

Market volatility is another major potential risk for spread bettors. 

The financial markets may move dramatically following certain economic events or releases of economic news, such as a change in interest rates. A market that you’re spread betting on can gap, or jump, to a much higher – or lower – price level even in just the matter of a few seconds.

This poses three possible dangers, all of which can translate to large trading losses:

  • If you do not have a stop-loss order in place, a sudden, severe market move may result in your holding a position with a huge open loss.
  • Even with a stop-loss order, you may sustain losses much larger than expected, as your stop-loss order may be filled at a price level far beyond that noted on your order. There is a way to avoid this: by paying a small fee you can secure a guaranteed stop-loss order. For example, if you have a stop-loss order on a certain stock bet at £48, even if the stock’s price suddenly drops from £55 to £35 with no intervening trades, your stop-loss order will still be filled at the specified price level or £48.
  • If you lack sufficient funds in your spread betting account to enable you to hold your bet position when the market makes a large move, your spread betting firm will automatically close out your trade at a loss even if you wished to hold onto it.

As a spread bettor, you must maintain awareness of the fact that financial markets are ultimately unpredictable and that there can be rapid price changes, which may or may not be in your favour.

Be sure to monitor when major economic reports are due to be released and consider whether or not you want to risk holding your spread bet during such a news release that can potentially result in huge price swings in the market you’re trading.

The risk of trading costs

Although spread betting does offer substantial financial advantages – such as not having to pay stamp duty or capital gains tax – that doesn’t mean it’s free. Spread betting firms don’t charge commission. Instead, spread betting companies make their money through the spread itself.

For this reason, you’re smart to shop around the various spread betting firms to find one that typically offers the lowest spreads. Trading with narrow spreads versus wider spreads can make a huge difference in your profitability over the long term.

Trading with narrow spreads versus wider spreads can make a huge difference in your profitability over the long term
It’s especially important to be aware of trading costs if you’re a spread bettor who holds bet positions for extended periods of time. Depending on the positions you hold, you may incur funding costs on a daily basis.

If you hold a bet position for a long period of time, even if the market gradually moves in your favour, it may turn out that the total funding costs add up to more than your profits or at least significantly reduce your net profit.

In the case of holding onto a losing bet over a length of time, funding costs alone can eventually eat up the margin you’ve put down for the bet and require the deposit of additional funds if you want to continue to hold your bet.

Handling spread betting risks – risk management

The fact that there are some identifiable risks to spread betting doesn’t mean that you can’t make money spread betting. It simply means that you need to exercise appropriate caution. Through the use of good risk management, you can minimise the dangers of financial of spread betting.

… you should approach the financial spread betting markets with a specific trading strategy
Good risk management doesn’t start with a specific financial move – It starts with having a good trading strategy for spread betting. Rather than trading impulsively (a common mistake of beginning spread bettors), you should approach the financial spread betting markets with a specific trading strategy that helps you to identify such things as low-risk entry points, profit targets, and where to place stop-loss orders.

Keeping losses to a minimum is another key aspect of good risk management.

The best way to accomplish this is two-fold:

  • Carefully calculate how much you are willing to risk on any given spread bet.
  • Place stop-loss orders in order to avoid exceeding your calculated risk level and potentially incurring a much larger loss. If you spread bet in markets that tend to be especially volatile, consider using guaranteed stop-loss orders that will ensure that you don’t incur any loss beyond your specified stop-loss price level.

Make certain that you know the financial markets that you want to spread bet on thoroughly. It is not wise to spread bet on a market that you’re not familiar with. Some financial assets that are available for spread betting are very complex instruments.

Get familiar with the price movements of a particular financial asset before you ever risk real money by betting on the asset. In particular, get to know how the market price of the asset generally tends to move, how volatile price movements typically are, and what economic announcements, events, or other factors tend to drive price movements of the asset.

It can be helpful to use charts to review both recent and long-term, historical price movements of the asset in order to get a good idea of how price movements tend to unfold.

Summary

You need to be aware of the inherent risks that are as common to spread betting as they are to any sort of financial trading. Such risks, as detailed above, include trading with high amounts of leverage, market volatility, and the risk of trading costs eroding your profits.

As long as you know the risks and practice good risk management in order to minimise them, you’re improving your chances of being successful. 

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