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Spread betting: Setting your own size

One of the most important facets of

successful trading involves position sizing – that is, having a

larger position when the market is going your way and smaller

positions when it isn’t. That concept is treated a little

differently in U.S. markets than it is in the United Kingdom and

other markets.

In the U.S. stock

market investors can buy as many shares as the size of their account

can handle. While 100-share increments are more typical, you could

buy only a few shares if that’s all you could afford.

In the U.S. futures

markets contracts are a specific standardized size. For example, a

corn futures contract is 5,000 bushels at the Chicago Board of

Trade. At $4 a bushel, the total value of that contract is $200,000.

To trade a corn futures contract, you must put up an initial

performance bond or good-faith deposit (margin) of about $1,200, an

amount set by the exchange.

A number of futures

markets have both full-sized and mini-sized contracts, but the point

is that if you want to trade any contract, you must have in your

account the minimum amount of money required by the exchange for

each contract, no matter whether you trade large or small numbers of

contracts or whether you have lots of money or only a little money

to trade.

A different view

“Spread betting” takes a different

approach. Instead of buying or selling a stock or a futures

contract, you can bet as much or as little money as you want on your

opinion about whether the market will rise or fall. The difference

in prices between the time you buy and sell – or sell and buy – is

the sole basis for the bet. The amount you bet is up to you.

Although the term

is familiar to European traders, “betting” is not a term U.S.

trading industry officials like because of its association with

gambling; instead, they prefer to call it “speculating.”

Regardless what you

call it, spread betting operates much like the betting on sports

outcomes or like the cash forex market with its bid-ask spreads.

Let’s say you have

$5,000 (about £2.600) to invest and are interested in buying Toyota

Motor Corp. stock, which has been trading in the $130-$135 (£68-£70)

range, a rather lofty level for many small investors. If you pay the

full amount for the shares and do not buy on margin in a normal

equities transaction, your trading stake can’t even buy 40 shares,

assuming you would want to put all your investment money in one

stock in the first place.

But, to keep the

math simple, let’s say you buy 40 shares and sell after the stock

rises from $130 to $140 (from £67 to £72), about an 8% advance that

puts a $400 (£205-£210) gain in your pocket (not including

commissions or fees and not factoring in possible gains from

dividends).

Tailoring your amount of risk

Depending on the amount of time you

held the Toyota stock, an 8% return isn’t so bad. But let’s say you

want to be a little more venturesome, on the one hand, but yet more

conservative on the other because you don’t want all of your money

tied up in just one stock and would prefer to spread your risks over

several stocks or to keep some of it in cash in your account.

With spread betting

you can specify how much you are willing to bet on each point change

in Toyota’s share price, using the bid-ask spread to either buy or

sell, depending on your market view. You may be willing to bet only

$2 (about £1) per point, using some of your funds to bet on other

stocks or other markets. Or you may want to risk $50 (£26) or $100

(£52) per point on Toyota. You determine the size of your position

and the amount of your risk by the amount you are willing to bet.

Like futures,

spread betting is also based on margin, which means that you only

have to pay a deposit and not the full amount at the time the bet is

placed. Normally, the deposit is based on a percentage of the bet.

(Keep in mind, of course, that if you bet a larger amount per point

and the price of the market goes down from your entry point, your

risk will also be much greater than if you bet small. That is a

truism in any vehicle where gearing or leverage is a factor.)

Big business in UK

Financial spread

betting in the United Kingdom resembles futures and options trading,

but there are some differences. In addition to the leverage

factor in both markets, one of the big positives of spread betting

is that, unlike gains from futures or stock trading in the United

States, all of the profits in spread betting are free from capital

gains taxes. Spread betting is not only more flexible in terms of

position size but in the type of instruments that can be created

quickly and easily without needing to go through a regulatory

bureaucracy. As in cash forex trading, all bets are between the

market-making company and the customer and are not executed or

cleared by an exchange.

One disadvantage of

spread betting in equities is that you don’t own a piece of the

company if you are betting on a stock’s price, and you have no

voting rights and no right to receive dividends. You are not an

owner but only a temporary speculator on price change.

Here are some of

the markets where spread betting is allowed:

• Indices such as

  FTSE and NASDAQ

• Individual

  shares from the FTSE 100 and FTSE 250

• Currencies

• Commodities

  such as metal and oil

• Short-term and

  long-term term interest rates

• Futures and

  options

• Bonds

According to Wikipedia, the largest part of the official spread

betting market in the UK concerns financial instruments. The leading

spread betting firms include IG Index, City Index, Cantor Index,

Financial Spreads and CMC, which either make all of their revenues

from financial markets or have sports operations dwarfed by the

financial side. Figures for the second half of 2006, for example,

show that the income derived from financial spread betting at IG

Group, the largest of the companies, was £29.3m, compared to £3.8m

in sports.

As with any trading

where betting or speculation is involved, there is a risk of loss in

spread betting, and beginning investors should not get into this

type of trading unless they have had adequate training. Some markets

are highly volatile, so there is a chance of significant loss if a

stop-loss is not in place. Even experienced traders beginning to

spread bet should limit their bets to no more than perhaps 5% of

their overall portfolio.

Having an idea

about the future trend of the market is an important aspect of

spread betting. That’s where VantagePoint can be extremely helpful

because of its high accuracy in forecasting market direction. You

don’t have to know much about technical analysis or intraday price

action but can rely on VantagePoint’s forecasted price trends based

on intermarket analysis to see probabilities for which way the

market is potentially going to move and place your bet accordingly.

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