Home » Spread Betting » Spread betting explained » Spread betting explained – volatility

Spread betting explained – volatility

You might be wondering at this stage, why I have spent so much time explaining about the dangers and risks of financial spread betting, but haven’t actually told you anything about how to open an account, place a spread bet, or indeed how you make money trading the financial markets in this way. Well the answer is very simple – I hope that by presenting the site this was round, it will at least stop one or two of you, rushing in to open accounts, before you realise the risks involved. Opening accounts and trading is very easy – it’s understanding and managing your risk that is the hard part, and having the discipline to trade using a trading plan, and with proper money management rules in place before you start. Now part of managing risk is understanding the markets you are trading, and in particular the volatility of each, so let’s just consider this aspect for a moment before we move on to look at the more straightforward aspects of opening market positions, and managing our trading capital.

When you are involved in trading,  and listen to market commentators or so called experts, you will hear the term “volatility” banded about in all sorts of ways, and generally conveying very little meaning, other than markets have been “moving around wildly” today. So what is the definition of volatility, the various types, how do we know which markets the spread betting companies consider to be volatile, and why is it important to know anyway? Let’s start with a simple definition which is this – “The relative rate at which the price of a financial instrument moves up or down, and is found by calculating the annualised standard deviation of the daily change in price”. Now it is important to realise that volatility analysis looks backwards, as we are analysing historical data (the only volatility that looks forward is implied volatility). So let’s just keep things simple with historic volatility.

Now without wishing to bore you with more maths, for those of you who can remember back to your school days, you might have vague memories of standard deviation and a thing called normal distribution, or the bell curve – a graph that looks like a bell ( hence bell curve). The norm ( or average if you like ) is the centre line of the curve and the graph is plotted by the number of standard deviations from the norm that a price occurs ( often called variance ). The key point is that all market instruments, whether indices, stocks, currencies, options, commodities, or anything else, will be measured in terms of their likely standard deviation or variance from the norm, and hence their likely volatility on a day to day basis ( or whichever time frame you feel is appropriate ). Now this does not mean that the instrument will not move away from the norm by more than one standard deviation ( it is generally there around 68% of the time ) or by up to 2 standard deviations ( generally 95% of the time ) it will, but only very rarely. So by looking at the historic bell curve for any trading instrument we can form a view on the likely volatility of the instrument in the future. Now the good news is that the financial spread betting companies have already done the hard work for us, so we don’t have to go back to school, and we’ve already looked at it earlier – it’s called the IMR or deposit factor which tells us a great deal about the instrument and it’s likely volatility.

Comparing historic volatility in the spread betting market is very easy as all the information is contained in the market information sheets for each product, and in essence the higher the number then the more volatile the market. It’s as simple as that! – the name may vary from company to company and will either be referred to as IMR, initial margin, deposit margin, or deposit factor, but will always be a whole number generally anywhere from 20 or 30 up to a few hundred. Below are some typical examples from various spread betting company sites with the typical ranges that you will find depending on the spread betting company you use:

  • UK 100 index: between 125 – 200
  • Wall Street : between 200 – 500
  • Japan 225: between 500 – 750
  • Gold: between 200 – 300
  • Silver: between 50 – 150
  • Copper: between 500 – 600
  • GBP/USD: between 250 – 375
  • EUR/GBP: between 130 – 150
  • USD/NOK: between 1400 – 1600
  • US Crude: between 350 – 400
  • Wheat: between 75 – 150
  • US T Bonds60 – 70

Now, when you are checking the above figures you will find two things interesting. Firstly, not all the spread betting companies will have the same value for a particular market, so if you are looking to trade in oil for example, then it is worth checking who requires the least margin for trading your particular market. Secondly you will come across terms such as “daily markets”, “rolling markets” and “expiry markets” which I will explain shortly. The important point is that the number will indicate the volatility of a particular market or instrument and you should use this information accordingly. There are many other ways to measure volatility using technical indicators such as the VIX ( for equity markets in general, and is a measure of fear and complacency in the market) and the ATR ( average true range ) indicator for the FTSE, which takes an average of the highs and lows of previous days – again, all of these are subjects in themselves, and using the above numbers should only be used as an initial guide and not the end of your research. Read and research you market carefully and understand it’s nature, before you start to trade.

As a new or novice trader, particularly if you have never been involved in financial spread betting before, you should start with the least volatile market you can find. If you are proposing to trade in an index, then start with the FTSE 100, not the DOW, if you are interested in commodities then start with silver, not copper, and if you are trading in currency, then start with the boring old EUR/GBP, not the USD/NOK!!! I hope I’ve made the point. There are a huge number of markets and instruments to choose – please start sensibly.