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Spread betting explained – money management

The remainder of this page will talk about figures, but only in percentages – why? – because I have no idea how much trading capital you have, so that in order to make this meaningful for you, simply apply the percentage figures to your own situation. So we have opened our financial spread betting account, and deposited our funds, and we decide to open our first position in the market. We know all about the market, and the likely direction, so how much should we risk on our first venture into financial spread betting?

Let’s start with a simple example which I hope will make the point. If we used 100% of our capital on the first bet and lost, how much trading capital have I got left? correct – nil – I am out of the game. Suppose I am more conservative and only risk 25%. The question now becomes how many spread bets can I get wrong before I am out of the game? – four. I’m sure you are starting to see the point. So the question is, how much of my trading capital should I risk on each trade? My suggestion is a maximum of 1%, yes 1%. If I told you that most professional traders would be horrified at this, as they work on 0.25% or 0.5%. What this means is that you can get 100 trades wrong, one after the other, before you are wiped out, whilst they will look for anywhere between 200 and four hundred – why? Because a thing called drawdown happens ( it happens to all of us at some time or another ) – put simply it is a run of trading losses which never seems to end. To survive you will have to practice the simple money management techniques I am explaining here. In simple terms, if you lose 50% of your trading capital, you have to make back 100% in order just to recover, which in trading is almost impossible. So if you started with £1000, but lost £500, in order to get back to £1000, you have to make another £500, which as a percentage of your remaining capital is 100% (500/500).

  • So my first money management rule is never risk more than 1% of my trading capital on any trade. If you only have £1000 of trading capital, your maximum risk on the trade should be £10.

So we now know how much to bet, but how does this work in practice? Well taking the above example, let’s assume the unit size for the market was 1, and the minimum bet size was 50p, then we would set our stop loss, 20 units below our entry. Our maximum loss on the trade is then 20 x 50p or £10. The immediate response whenever I explain this is that the stop is too close, or the spread betting company only offers a minimum £2 per unit size. In that case you are under funded and need to increase your spread bet trading capital, to bring it back into line. If we work backwards, let’s assume you want a 50 unit stop loss as you feel the market is volatile and you don’t want to be stopped out all the time. Your risk is therefore 50 x £2 = £100, so your trading capital needs to be £100/1% ( or put another way 100 x 100/1) = £10,000. The single reason most people fail at financial spread betting, and indeed many others is because they have insufficient trading capital. I know it seems a great deal of money but that’s how much you need if you are prepared to risk £100 on a trade – the maths is very simple. The problem is that most people risk this amount but only have £500 in the account – there’s only one winner and it won’t be you I’m afraid – sorry. If you only have a small amount of capital then this market may not be for you, but wherever you trade, the same simple rules will apply. Finally, and before anyone writes to me, I am not suggesting that this is the guiding principle for placing your stops – it isn’t. You need to look at the charts for possible areas of support, resistance and other signals and then combine the money management aspect with your technical analysis of the charts to find the most appropriate place for your stop, using both approaches.

  • My second money management rule is also very simple – never have more than 10% of your total trading capital at risk at any one time.

The reason for this is very simple. If the markets suddenly move against you in a large move, you do not want to have more than 10% of your trading capital exposed. To recover a 10% loss is possible, it only needs an 11.1% recovery to get back to your starting point which is achievable. The more you lose, the harder it is to recover. So how do we convert this to the number of trades we can have at any one time – very simply. If we work with the £10,000 of trading capital, and assuming all the positions we have are at £2 per unit size and we work on the 1% stop loss rule, then the maximum number of open positions would be 10 as 10% of our capital is £1,000 ( each one has £100 or 1% at risk). Now clearly in your case, the maths will be a little more complicated as unit sizes will vary and as will the bet sizes, but the same principles apply. Please bear in mind these are the absolute maximums I would recommend, and if you have the choice I would reduce these further – working with 0.5% trade size and 5% trading capital exposed is even better.

Now let me finish this page by talking about something called stop hunting which you may have come across in your spread betting research, and wondered what exactly it is? In essence it is your broker taking advantage of his unique view of your positions in the market, to take out trades by hitting your stops. Does stop hunting happen? Of course it does I’m afraid, and it is always the argument put forward by traders not to use stops. When you are trading against a broker or spread betting company then it will happen. Which companies allow it and which don’t is impossible to say, but I would also suggest it is often used by traders as an excuse for poor stop management, or a lack of knowledge of out of exchange hours trading. For myself, I have never experienced this problem as far as I am aware. I am always worrying more about locking in risk free trades, than the odd ones that go against me. So don’t use this as an excuse not to use stops – it doesn’t wash ( well not with me anyway!)