How to use Leverage Safely and Successfully - Spreadbetting and CFDs Part 4 of 7

An Unexpected Danger during the Credit Crunch
This section is a word of warning and something to be aware of. It has only happened to me once, during the Credit Crunch, but it was really very, very, unpleasant.

What happened was that my Spreadbet Companies changed their Margin Rates as the turmoil in Markets occurred. It is easiest to explain this with an imaginary scenario - let’s say the Margin Requirement was 10% of my Portfolio and I had £200,000 of Exposure. This would mean that my Initial Margin Requirement was £20,000, so I had to have AT LEAST that amount of money just tied up in the Account as Margin (Deposit) to keep the Positions open. Now, let’s imagine the Spreadbet Company increased the Margin Requirement to 20% - this would mean I now needed £40,000 or they would close down some of my Positions until the Exposure fell back enough and the Cash rose enough to get back into balance.

As you can imagine, suddenly having to find a load more cash when markets were in meltdown anyway was a nightmare. So make sure you always keep your overall Spreadbet Portfolio Exposure to a level that you could cope with if your Spreadbet Provider suddenly upped Margin Requirements on you.

Luckily for me, having experienced this once and felt the pain, I hope I am better prepared now and should handle it better if it ever happens again. These type of events are thankfully incredibly rare, but at least you have been warned.

Overseas Stocks
I also do some US shares (I have EBAY at the moment) where using Spreadbets with a £ Sterling Stake can avoid the US Dollar risk. This also adds some more diversification to the 'Mirror' Portfolio. I have also used Spreadbets for Euro denominated stocks like Volkswagen, Airbus, etc.

For Example, EBAY is currently priced around $57. If you buy as Normal Shares from the UK, you need a US Dollar based Share Account and you run the risk of currency fluctuations - on top of the usual Risks that go around any Share Purchase.

With a Spreadbet, EBAY would show on the igIndex Platform at around 5700 (this is in Dollar Cents) and you could bet £10 a Point which would give an Exposure of £57,000. Note, even though this is a Dollar Denominated Stock, you would only have exposure to £ Sterling - neat isn’t it?

This reminds me - as a General Point, make sure you understand what the Unit (“Per Point”) measure is. For instance, if a Stock is £170 and you think £10 a Point gives you Exposure of £1700, you will be in for a shock when you find that it is £10 for each 1p move (pence) and your Exposure is £17,000.………

IPOs
While I think of it, similar to the above, I find that  with igIndex I sometimes get the chance to Buy a Long Spreadbet on a newly Floated Company while it is still trading in the ‘Grey Market’. This is fantastic - with Normal Shares you have to wait until ‘Conditional Trading’ (for Institutions only) has ended and Normal Trading resumes - this is usually several days after the IPO and you miss out a lot. Worth watching out for.

Types of Stoplosses with Spreadbets
There are a few types of Stoplosses that igIndex will provide on their Trading Platform - I expect that most other companies will offer similar types. For information, they also do Limit Orders and stuff, but I rarely use them. I think there is also a ‘Trailing Stoploss’ function but it is a general one that applies to all of your Positions - or at least that is how it used to be - you have to set a Percentage level at which the Trailing Stop will kick in for all your Positions. Seems a bit limited - maybe it is better since I last looked at it.

The ‘normal’ Stoploss is one where the Stoploss Level you request is not guaranteed. What this means in practice is that in certain circumstances, on a Long Position for example, the Price could race downwards and actually shoot past your Stoploss Level. This can mean that your Position can get closed way below your Stoploss Level, so you incur more of a hit.

So, for example, let’s say you bought a Long Spreadbet at 110p in an imaginary Stock and you set a Stoploss to trigger at 95p. The Price then tanks and shoots past 95p, so that you end up having the Position Closed Out at 90p. Obviously this is pretty annoying.

The way around this problem is to have a Guaranteed Stoploss which is the other option that igIndex offer. In this case, the Level you request is set in stone and your Trigger Level will be honoured. The catch is that you pay a bit more on the Spread for this peace of mind - but it is probably worth it.

Profit Warnings
There is not much to say here, but I just wanted to highlight how I sometimes play things. If one of my Stocks does a Profit Warning and goes nasty, I occasionally keep the Normal Shares but I close the Spreadbet - because further Warnings (remember, Profit Warnings tend to come in 3s) will cause more ‘trouble’ (and squirming) in my Spreadbet Portfolio than as Normal Shares. This has the effect of almost halving my Exposure to the Company and if and when the Stock starts to recover, I might Buy a Long Spreadbet again.

Another trick I have used one or two times in the past is to totally ‘Hedge out’ a Long Exposure I have to a Stock. For instance, say I hold a Share that I really like and I think there is just a Short Term issue that is a big worry. In this case, I might actually do an Offsetting Short Spreadbet on the Stock to the same Exposure Amount as the Normal Share position I hold. This will mean that I now effectively have Zero Risk from the Share but I am still in the game and if things get resolved, I just close the Short and we are off to the Races again.

You can object that I might as well sell the Shares, but the danger in this is that cognitive ‘Recentcy Bias’ (how do you spell that?) may mean I forget about this wonderful Stock and get distracted by something else, and I miss out on the upside. It is not a great solution and I have only done it occasionally but it is another ‘trick’ in the Armoury.

Shorting with Spreadbets
It’s really just the opposite of going Long or Buying a Position. You are going Short or Selling a Position.

It works the same way. Let’s say you want to short the FTSE100 at 6830 at £3 a point. You would have a Short Exposure of £20,490 (£3 x 6830). One thing to point out here also, is that Margin Requirements for Indexes are tiny - in this case, it would probably be about £75 or something silly. There is a Danger here - don’t lose sight of your Exposure on a bet - just because you can use £1000 to give you exposure of £1,000,000 it doesn’t mean it is a good idea to do it !!

When you want to Close the Short Position, you ‘Buy’ the Spreadbet back. This is the opposite of when you Close a Long, where you ‘Sell’ the Spreadbet.

Shorting Individual Stocks is very difficult and dangerous. I rarely do it in Bull Markets and always use a  Stoploss - because your potential Risk is unlimited - a Share you are Short on could go up and up forever !! (and believe me they do have a habit of doing this when I short them - even if they are total cr*p - the Market can remain illogical for a lot longer than you can stay solvent……..)

Conversely, on a Long Position, your Risk is ‘Limited’ to 100% - a Share Price cannot drop below Zero (they do this a lot for me as well !!).

I tend to use Short Spreadbets for Hedging my Long Portfolio via the FTSE100. Please see my Blogs for details on how I do this - best to look under the ‘Trades‘ category.

How Margin / Deposit Rates are determined
From my understanding, Margin / Deposit Rates depend on a particular Asset’s volatility. This means that Smallcap and AIM Stocks which tend to whip around like crazy things, have much higher Margin Requirements than those of more steady FTSE100 Stocks. On the smaller stuff, Margins can be 20% or maybe 25% of Exposure, on the Big Stuff, it can be as little as 5% to 10% of Exposure.

I have even seen on some Crazy Bulletin Board type Stocks that they want 100% Margin !!

As I have mentioned earlier in this Blog Series, Margins on Indexes are tiny - they are not so much done on Percentages but by a Pounds figure per point. For the FTSE100, I think it is something like £25 Margin for each £1a Point you bet. For instance, if you bet £20 a point, your Margin need would be £500 but your Exposure would be vast - around £140,000 - so that is about 0.35% !!

For each Asset you decide to place a Bet on, you need to check the ‘Information’ tab to find out what the ‘Margin Requirement’ is. When you go to place the Bet with igIndex, it tells you what the £s figure for the Margin will be at the Opening Price, just before you hit the ‘trade’ button.

Strangely, Forex and Commodities have pretty low Margin Requirements - silly really as these things can be mega volatile. I don’t mess with them - so it’s Someone Else’s Problem……..make sure it’s not yours !!

You may have noticed that this 5 Part Blog Series has become 7 Parts - as usual, the more I think about it, the more I feel a need to shove extra detail in. Anyway, the end result should be pretty comprehensive, which befits such an Important, Useful and Dangerous subject area really.

I am sorry the Structure has got a bit muddled as I have added bits, but I am confident it is all good stuff so stick with it despite the shortcomings.

Hope you are still awake…..wd