How to use Leverage Safely and Successfully - Spreadbetting and CFDs Part 6 of 7

Restrictions on opening Accounts with igIndex
I suspect that most Spreadbetting Companies have similar qualifying criteria for an Account. You need to be over 18 to apply and they will put you through a Credit Vetting procedure. If you are in Full Time Employment it is probably a lot easier to get an Account than if you are not Employed; in the latter case you may need to provide proof of Assets or something - I do not know how this is handled.

If you are deemed to be an inexperienced Investor, they will only let you have a ‘Limited Risk’ account - this means that you will have Guaranteed Stoplosses on every trade. This might be ok for some people, but for the way I do things, it would not be very helpful. If you are ‘Experienced’ (I think you need to indicate that you have been Investing in Shares for some years) then you can have a ‘Normal’ Account, which to my mind is much more useful.

However, I know many people use Stoplosses all the time and if you are one of these people, then you will have no issue with a Limited Risk account. As I said in an earlier part of this series - use a Mirrored ‘Virtual’ Spreadbet Account in exactly the same way as you use your Normal Share Portfolio. Deviations from this will probably cost you money - I know, because I am convinced that my ‘messing about’ hits my Spreadbet Returns !!

If you are only able to get a ‘Limited Risk’ Account, it just means that you will have to put a lot of thought into carefully timing your Entries into Trades and setting your Stoploss Levels very carefully. You may find that after a period of using such an Account, you can persuade them to upgrade you to a ‘Normal’ Account.

Start Small and Build Up Slowly
The heading to this section sums it up really. If you have never done Spreadbetting or Leveraged trading before, then start with Small Exposures and build it up slowly and carefully. This stuff really is very Dangerous and if you get it wrong, it could wipe you out Financially.

Do not undertake any type of Leveraged Trading if you do not understand fully what you are doing. My Blog Series on the subject pretty much covers all of it - so make sure you read and read again until you get it. No point trying such Tools if you don’t get it. You will lose money FAST.

And make sure you understand the concept of Exposure and its implications especially.

I only create a 'Mirror' Portfolio well within the levels of Cash and Assets I have. What I mean by this is that say, for example, that I had Cash in the Bank of £50k for a 'Rainy Day' (that's funny, with UK weather I will be eating into that Cash pile !!), then I would only do Exposure in the Mirror Portfolio up to £50k - so, in theory, I could never go bankrupt. 

If you think about it, even in an extreme and rare Event like the Credit Crunch, my Portfolio would probably fall a maximum of about 50% - so I would always have plenty of cover, and I would just wait for things to recover. In fact, this is the sort of thing I did in the Credit Crunch - although I actually closed some positions and put on some Shorts so it was not an issue for me, although I did take a sizeable hit that year and it was not pleasant. I made some dosh on Shorting the Banks though !!

Controlling your Exposure and managing Risk
I will apologise slightly for the repetitions throughout this Blog series but I really feel that they are appropriate to stress the Dangers inherent in Leveraged Trading. This next bit repeats to an extent but it is vital that you understand it.

In an earlier Blog I talked about an example where the Cash and Margin level in my igIndex Spreadbet account vary all the time. As prices of the Stocks in my Mirrored Spreadbet Portfolio wiggle around intraday, the Margin Requirements and the ‘Cash Available’ in my Account go up and down with them. I often refer to the ‘Cash Available’ as my ‘Buffer’ - this is a pool of Cash that is used to cushion the effect of any adverse movements of my Positions.

This ‘Buffer’ is essential to my Approach and I normally like to have about 5% to 10% of my Total Spreadbet Exposure (note this is Net Exposure - i.e. my Longs minus any Shorts) in this Buffer. The way it works is that if your Buffer gets wiped out, then the Spreadbet Provider will ask you for more Cash to replenish the Buffer (this is known as a ‘Margin Call’). If you do not put more Cash in immediately, then the Provider will start closing your positions until your Exposure falls sufficiently and your Cash Buffer goes up (remember, as Positions are closed this frees up the ‘Margin’ or ‘Deposit’ that was tied up to support the Positions - so this freed up Margin goes to boost your Buffer). Obviously, Sods Law dictates that they will close the Positions you least want them to close first !!

With igIndex, they tend to give me a lot of leeway on Margin Calls - first I get an email and it seems like I have quite a lot of time to put the Cash in - a few hours. Because I always know my Exposure and have a good Cash Buffer, I never get caught out by this and if the Market was falling fast and I was Net Long, then I would pounce on my Tablet or Fone and check the situation regarding Cash Buffer straight away. I think igIndex may start doing Margin Calls by TXT message as well soon.

Let me be clear that I fully accept Ups and Downs of my Stocks and that I am not bothered about my Account being in a Huge Loss if I have plenty of Cash to back it up and I am managing things properly. I am a Long Term Investor not a Trader. I think many people are unable to realise the difference between a Permanent Loss of Capital and a Temporary Short Term Loss of Capital……Long Term Investors should not be overly concerned by the latter, in fact, it creates opportunity.

Think about it this way. If I have £50k of Normal Shares and they drop 20% my Portfolio will be down £10k and I will be peed off but I will still have £40k in my Portfolio and I know that as a Long Term Investor, this can happen in tough markets - I have quality Stocks and they will recover. However, in exactly the same scenario with a ‘mirrored’ Virtual Spreadbet Portfolio, a 20% drop will look like my Account is doing terrible because I will be £10k down and I probably only put £10k in the Account in the first place and I have had to add to the Cash Buffer. However, this is exactly the same - it is just a psychological difference. In both cases I am down £10k and I still have Long Exposure of £40k - so when the market recovers, I will be in exactly the same position.

Weird, ain’t it?

Another way to think about it is that in the example of the above Normal Share Portfolio worth £50k, you have to put up £50k of Capital to do it. With the Mirrored Virtual Spreadbet Portfolio of £50k, you only need about £15k of Capital to set it up - and some more Cash set aside to allow for Bad Times and big Drawdowns on the account. In practice, I suspect you would need about £25k in reserve for such a Virtual Portfolio - I tend to have 100% of my Spreadbet Portfolio Exposure in reserve - this is safest.

A Short Cut to measure Exposure fast
I have found over time that my Exposure is fairly easy to calculate to an approximate (and useable) level - I established this from calculating the Total Amount laboriously and found that the Ratio of Deposit to Exposure tends to be around 1 to 5. In other words, for my particular make up of Portfolio, I find that my Exposure is roughly 5 times my Deposit or Margin. This is a quick and easy method but it depends on the make up of the Portfolio - other Portfolios may be 4 times or 6 or 8 times etc. If you are going to do a similar Short Cut, then it is best to work it out in detail a few times until you establish a sensible metric to use for the multiplier. If you have more smaller stocks that need bigger Deposits, then your Exposure multiplier will be nearer 4 times your Deposit. If you have mostly FTSE100 Stocks, then you may find that your Exposure is as much as 8 times your Deposit - be careful.

Well, that’s Part 6 survived (if you got this far), just one more to go.

I hope this stuff is getting the old grey matter fired up, I am certainly having to think about it.

Guten Tag, wd