Money Management for Spread Betting

Understanding money management

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Manage your money or lose your shirt!

Making money from financial spread betting is only one half of the story. The other half that is required if you are to emerge profitable from spread betting over the long term is preserving what money you do make.

Most successful traders and pro spread betters would agree that effective money management is the single most important factor that determines long term profitability in the stock and financial markets. What is much more difficult to get agreement on is the best method for implementing money management. As discussed in this article, there are various approaches to money management.

Money management in practice

You need to ensure that the approach that you adopt provides satisfactory answers to the following crucial questions:

• What proportion of my available spread betting capital should I risk on the next trade?

• How large should my stake be to ensure that I remain within the acceptable risk limits?

Now, there are many alternative theories and rules of thumb providing various answers to these questions. One common rule of thumb is the fixed percentage rule. This is explained further below:

The Fixed Percentage Rule

Basically, this states that you should establish a fixed percentage of your capital that you will allocate to each spread betting position. For most professional traders and some experienced financial spread betters with sufficiently large spread betting capital, this fixed percentage is about 2% BUT this is not a magic number. So don't treat it as such!

Taking the 2% as our starting point, this means that if you have £100,000 in your account, the maximum loss that you can take on any single spread bet is £2,000.

Position Sizing (or how to determine your spread betting stake)

Once you have established the maximum loss that you are comfortable with on a single spread bet, you are left with one more decision: how do you ensure that what you actually lose is no more than the stated maximum loss level?

Approach 1: Use of Notional Trading Requirement (NTR) or Margin Factor

Financial spread betting is a margin instrument. This means that when you place a spread bet, you are only required to put up part of the funds. The amount required is the initial margin deposit. The margin factor is the amount of money that you need to have in your spread betting account in order to bet £1 per point on the stock or other security that you are interested in. So, for example, if your spread betting broker requires a minimum of £200 in your account for you to bet £1 per point on the FTSE 100, then the margin factor in this case is 200.

You can use this margin factor to work out how much to spread bet for each point movement in the underlying instrument. The best way to understand this is with the aid of an example. Let’s look at the one below.

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Long on ABC (i.e. buy ABC)

Available spread betting capital..................£100,000
Maximum Loss Percentage.........................2%
Maximum loss per bet ( = 2% x 100,000).................2000
Margin Factor (provided by the spread betting company)...200
Maximum Spread bet stake ( = 2000 / 200)..............10

This approach requires that you exit the trade if you lose as much as the stated margin factor, so essentially, the margin factor is your implied stop loss level.

Approach 2: Reference to critical stop loss levels determined with technical analysis

An alternative to using the margin factor involves setting a stop loss level and then measuring the distance between that stop loss level and your entry level. You then divide the total amount that you are willing to lose by measuring the gap between the stop loss and your trade entry point. This approach is illustrated in the following example:

Long on ABC (i.e. buy ABC)

Stock price at purchase...........................1000 pence
Set stop loss level..................................900
Stop loss allowance (= 1000 – 900)...................100
Available spread betting capital....................£100,000
Maximum Loss Percentage..............................2%
Maximum loss per bet ( = 2% x 100,000)...............2000
Maximum Spread bet stake ( = 2000 / 100).............20

As with the previous approach, this take on money management requires that you have the discipline to exit the trade as soon as your stop loss level is triggered. This is where the fine lines between money management and trade management can become blurred in the eyes of the novice trader. Furthermore, most novice spread betters hesitate to take a loss in hope that the market will recover to give them back their money. This is a dangerous game to play.

While the approaches to money management discussed here may seem simple to the pro spread better, most novice spread betters would probably require some time to get used to these concepts. However, I cannot over emphasise the importance of having a solid money management strategy in place. Not only does it cover your downside risk of losing money, it also increases your chances of making money by ensuring that your spread betting is disciplined.

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Understanding the foreign exchange markets

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