It didn’t make the deadline for the first publication of my Better Spread Betting book, but here’s what Ajay Pabari, Founder and CEO of Spread Co said in response to my question “If you could give just one piece of advice to a spread bettor, what would it be?”:
Be smart in the use of leverage. Margin can be a very good thing. We all recognise a spread bet is a leveraged product, but then for most UK individuals, so is buying a house. When you buy a house in the UK, you pay a small deposit and you get your bank to give you most of the funding of the purchase price. Margin is what you call the small deposit that you put down when securing a spread bet trade.
The unfortunate thing about margin is the misconception it has been given. The margin rates for spread bets are set by reference to the volatility and liquidity of the underlying instrument. When you put a minimum deposit down in order to open a trade, even a small movement in the price of the underlying in the wrong direction will mean that you may have to pay additional funds as the position goes against you. This is what frightens people off: the request to pay additional funds because they have only put down a small deposit.
What we recommend to clients is to try and put down a larger initial deposit, and not to go highly leveraged. In fact, perhaps start with no leverage at all. Get familiar with the product before you look to be clever with leverage.
I’m with Ajay on his excellent initial explanation of what “leverage” and “margin” are, and in fact I draw a similar analogy in my Better Spread Betting book. I’m not sure how you can avoid leverage in a spread betting account, and I’m equally unsure about depositing additional funds to meet a “margin call” (if that’s how you interpret Ajay’s suggestion); but I interpret it in a slightly different — and possibly more empowering — way:
If Spread Co or another spread betting company takes £200 of your deposited trading funds in support of a £10-per-point position on 100p-per-share stock, remember that you must have the balance of £800 deposited with the spread betting company or elsewhere (e.g. in a savings account) to cover your “true risk” of £1000 (£10 * 100p) if your chosen stock goes bust overnight. £200 leveraged at 5x gives the same risk as £1000 non-leveraged, and the sooner you realise this the sooner you can learn to love leverage.
One more thing: in this example you may be able to cap your risk absolutely at the £200 you thought you were risking in the first place, by deploying a guaranteed stop order placed 20% from your entry price. I understand that Spread Co is improving the support for guaranteed stop orders in this month’s trading platform update.
Several more things: If you’d like to know how other spread betting companies and well-known trading authors answered the same question that Ajay Pabari just answered, you can find out in the final chapter of my Better Spread Betting book.
Disclaimer: this posting is for general education only; it is not trading advice.