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Financial Spread Betting Explained

Posted May 27th, 2012 in Investing by Jeremy Waller

For those with an appetite for risk, there are a wide variety of derivatives that you can trade. When traded as a speculative investment, rather than as a hedge, they can be extremely high risk. Just ask JPMorgan Chase who lost well over $2 billion this month from trading naked credit default swaps.

On the other hand, derivatives have tremendous upside potential. But upside potential isn’t everything – the lottery has a great upside as well!

Spread betting is one of the many derivatives that allow you to speculate on the price movement of an underlying security. If you don’t mind the risk, a great way to make an additional income is spread betting.

Now, let me be clear here. You shouldn’t do this with your retirement portfolio. But if you have some extra money to play with, I don’t have a problem with speculative investments – as long as you are okay with the fact that you could lose 100% of your investment.

The Basics of Betting the Spread

Essentially, spread betting is placing a bet on the price movement of a security. Let’s say that Apple is trading at $550. You believe it is oversold and think that the price will rise over the next few weeks. You could use a spread betting firm to bet a certain dollar amount per point. If you buy a stake size of $10 per point then you gain $10 for every point that Apple rises. Conversely, you lose $10 per point that Apple falls.

Say after two weeks, Apple is trading at $575. You could exit your position, taking a profit of  $250 (25 point increase x $10). It works in reverse as well; if you exit your stake when Apple is at $540 your loss would be $200.

How to Manage Risk in Spread Betting

Stop loss orders can be used in spread betting in the same way they can be used when trading equities.

Before you open a new position, you should already know at what price you will take your profits and at what price you will cut your losses. As soon as you get into the position, immediately set your stop loss – allowing some room for price fluctuation, but tight enough that you won’t lose more than you can afford.

As mentioned above, the amount you invest should be a very small percentage of your portfolio. Never use money that you can’t afford to lose. Spread betting offers the potential for high returns, but also has the potential to wipe you out if you don’t effectively manage your risk.

 

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