One of the main advantages of margin trading such as spread betting and CFDs is the ability to make large gains through a process known as leverage.
Leverage or gearing means that using a small stake, can lead to relatively large profits (or losses). As opposed to margin trading, conventional share dealing, does not use leverage and requires the investor to lay out 100 percent of the cash to acquire the physical assets.
Basically the spread betting providers are lending you money to invest with. But you need to place a deposit, normally 10 percent of your position in your spread betting account.
For example, if I want to buy 1,000 shares in Barclays Bank at 100 pence a share, you would have to stump up £1,000.
However, if I wanted to buy the same position through spread betting, than I would place an order for £10 per point. You will need to outlay some margin (usually 10%), so in effect your capital outlay is a tenth of the sum needed compared to purchasing the physical assets with same exposure – let me demonstrate continuing with example above:
Conventional Cash trading –
Purchase 1000 shares at 100pence each, with a capital outlay of £1000. If the stock increases from 100p to 200p, then the profit will be £1000 (200p-100p x 1000 shares)
Spread betting –
Buy £10 per point, with a capital outlay of £100 (margin at 10%). If the stock increases from 100p to 200p, then the profit would also equal £1000 (£10per point x 100 point increase in price)
As you can see, the same exposure and profit is made on both methods, but with spread betting only a tenth of the capital is outlaid.
The advantages of leverage are therefore obvious – a smaller capital outlay can lead to relatively larger returns than traditional non-leveraged products, but it is stressed that losses are also magnified.
Carefully leveraged investors, who take advantage of stops and limit orders and make sure their capital float is not too large a percent of their total capital available- should be able to enjoy this method of investing. Caution however is always advisable.
In general, less liquid stocks require more margins to trade than more volatile or heavily traded stocks.
Opening a Share Trade
Opening a Long Position:-If you get a quote of 640-645p for shares in company X. You then place a buy trade after your research, the finding will be thus
|Opening Buy price||645|
|Quoted Sell price when bet is closed||665|
Using a rate of £10 per point, you bought the shares at 645, and then sold them back at 665, the spread is 20 points.
20 x £10 = £200 profit
Understanding Short Positions:-“Shorting” the market is terms most people use too often but don’t know how it works.
Going short on a share is where you agree to sell shares without actually buying them from the market. The expectation is that the share will soon fall in value below the price you have agreed to sell the shares in the first place.
Shorting the market is not a strategy that most private investors normally use, but it is a major option available to betters in the market. By ordering a “SELL” bet on a stock, you can make a lot more money but you could also face more risk than if you go long
Example – Opening a short position
Just like the previous example the spread betting company will quote you a spread of 640-645 for shares in company X. The sell price here will be 640p, the buy is 645p. You then place a sell trade based on your research and findings that the share price will fall, it might happen like this
|Opening sell price||640|
|Quoted buy price when bet is closed||610|
Still using a rate of £10 per point, you sold the shares at 640, and then bought them back at 610, the spread is 30 points.
30 x £10 = £300
You will make a profit of £300. Isn’t that great!!!