Sector Spread Betting Explained
Sector spread betting can enhance returns while mitigating risk
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Just as you can spread bet on individual shares, sector spread betting involves placing bets on entire industry/sector groups. This approach can be very useful if you prefer to gain exposure to a broad base of underlying shares, diversifying your risk.
For example, if you hold the view that the current economic climate would be very favourable for banks in general, you can decide to take advantage of this spread betting opportunity in a number of ways. You can drill down further, analysing each bank in turn to determine which ones would derive the most benefit from the favourable outlook.
While there is nothing inherently wrong with this approach, there are a number of reasons why it may not be the most efficient approach. It goes without saying that even where a sector performs very well, there will be individual shares that would still underperform the group. This risk may be mitigated by diversifying your investment across the entire sector. In this case, you simply spread bet on the sector index itself. There are over 30 sectors that you can spread bet on in the UK market.
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How to analyse sectors before you spread bet
As with shares, there are two principal methods for analysing sectors before deciding to spread bet. The two main approaches are:
- technical analysis, and
- fundamental analysis
Fundamental Analysis of Equity Sectors
To spread bet on sectors using fundamental analysis requires just the same approach you would use for individual shares.
You can derive valuation measures for broad equity sectors just as for the shares within the sector by using the following ratios.
PEG Ratio: this adjusts the P/E ratio for the expected growth rate of sector earnings. The PEG ratio is very popular in the City and on Wall Street as an indicator of a sector’s potential value.
P/E Ratio: this measures the price of the sector relative to the expected earnings across the sector. This indicates how much investors are willing to pay per pound or dollar of the sector’s earnings.
Using Valuation Multiples For Initiating Sector Spread Bets
For practical sector spread betting purposes, both the P/E ratio and the PEG ratio are not particularly informative on their own. Knowing the P/E ratio or PEG ratio of a particular sector is not sufficient. You need to be able to compare these with the equivalent ratio for the overall stock market. In the UK for instance, you would want to compare a sector’s P/E ratio with the P/E ratio of the FTSE 100 index. This would enable you to make an assessment about whether the sector in question is under valued or over valued.
Technical Analysis For Sector Spread Betting
Technical analysis is a very broad topic with numerous approaches and methods of investment analysis. In most cases, the best approach is to keep it simple if you want to ensure that your spread betting is profitable.
Generally speaking, the nature of technical analysis is such that any methodology can be applied across a variety of securities or markets. Hence, any technical tool that you currently use for individual shares can be adapted for use stock groups too.
One simple and very effective technical approach to sector spread betting is the use of relative strength. Once you identify the direction of the overall market (such as the Footise), you assess the relative strength of the various sectors that make up the index. Your sector spread betting strategy should focus on placing buy bets on those sectors showing relative strength while placing sell bets on those showing relative weakness. This simple strategy ensures that you are spread betting in line with the underlying market current.
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