Let’s Have a Quick Chat about Leveraged TradingOne of main problems with spread betting, CFD and forex is leverage. Helping yourself is actually very simple, it boils down to a reigning in of risk appetite.
Spread betting and CFD trading are leveraged and for many traders it is not actually their win:loss ratio that hurts them, but the level of leverage they take on – and usually inadvertently.
Let me give you an example – say you have £5,000 in an account and like the look of Lonmin which is trading at £10 a share.
Now, with margin requirements of as little as 3% at various firms you might be tempted to buy say £10 per point which will cost you an initial margin of £300.
You promptly do this and sit back, looking forward to making a few hundred pounds on your £300 initial investment…
You are in fact controlling £10,000 of stock and the volatility of a stock like Lonmin is such that it will easily move 2-5% on a given a day.
Get your entry wrong and see a 20p move against you (excluding the spread) and you are immediately ‘on margin’ – a place you never want to be, trust me.
Instead of leveraging yourself to the hilt, take a more measured and risk controlled approach and always calculate what the underlying ‘gross’ exposure is (this is also called the ‘notional value’). In this instance my notional value was £10,000.
This gives you a true and clearer reflection of the risk you are taking.
Remember You Are Borrowing From the Spread Betting CompanyWhen you spread bet you are in effect borrowing money from the spread betting company.
As above, with a deposit of £300 you are borrowing £10,000 and using that to trade on your chosen market.
Note this is why the overnight financing fees often seem high. You are paying interest on the £10,000 you borrowed.
My Trading Screen is Never a Sea of Green
Personal Leverage GuidelinesMy own personal rule of thumb when it comes to stocks is as follows: Adhere to the above and you might, just might, extend the life of your account and address the high probability of getting a number of trades wrong in a row without pressuring yourself with the enemy of all traders – the dreaded margin call!
Remember: Spread betting, CFDs and forex trading carry a high level of risk. You can lose more than your initial investment. These products are not suitable for all investors. Only speculate with money that you can afford to lose. Make sure you fully understand the risks involved and seek independent financial advice where necessary.