Many people in the UK trade by spread betting on the financial markets. IG Index one of the UK largest Spread betting platforms has a notice onsite saying, ‘75% of retail investor accounts lose money when trading CFDs with this provider’. The Financial Conduct Authority (FCA) released a study that found that 82% of people lost money on products called contracts for difference (CFDs).
There are a whole host of reasons why spread bettors lose, many in the same way as normal traders do.
The Markets Are unpredictable.
Many professionals lose money in the long term. With all the information, knowledge and tools they have, do others really have a chance. This links to many of the biggest debates in the investment and trading industry. Are the markets random? Are they perfect? (Meaning is everything already factored to the price and there is no edge to gain). Does technical or fundamental analysis work? There’s no debate as to whether long term investing can be profitable, but whether short term traders can predict the market and beat a ‘long term buy and hold strategy’ or even make a profit after fees over a long period of time is very debateable.
No trading plan.
You might be correct in predicting the markets in the short term, but the markets will fluctuate, that is certain and you can get hurt in spread betting. All professional traders have a plan for when they will enter and exit a trade. There are different tactics including key dates, prices, technical indicators and repositioning of stop losses. Whatever you use, you must have a plan.
Your edge isn’t enough to overcome the spread and fees.
Spread betting has a gap between the buy and the sell price, the spread. For some markets such as the FTSE100 this can be tiny. This is currently Buy at 6606 and sell at 6605. That’s just 0.015% . When you look at more volatile markets such as smaller stocks or crypto currency this can really grow. An example at the moment is NEO cryptocurrency. Buy at 11.937 sell at 11.537. That’s a spread of an incredible 3.35%. That means that market needs to move by more than this just to break even.
This doesn’t even include the fees. Some brokers are ‘commission free’ or don’t charge fees except the spreads. However, this can lead to a larger spread. Many sites do charge fees. There are many examples of this, and you really need to read the terms and conditions. These fees can go under the title of ‘overnight funding fees’, ‘guaranteed stop premiums’, ‘rolling over contract fees’ and there are probably more.
Betting on something you have no edge on or don’t understand.
The spread betting sites are full of opportunities and information. Through login to your dashboard, you will have been bombarded by opportunity. It could be that your homepage shows the world markets flashing away, there’s a new feed with opinion, you might have received an email talking about the next Bitcoin rally. However, it happens temptation at some point overcomes many of us.
You will also come across complicated products which take real skill to trade on. Options are one of these.
You might be correct in the long term, but wrong in the short term.
This will happen and it’s so frustrating. You knew that Perfect Company Ltd would rise for a week after its next earnings report, but to protect yourself you set a stop loss, many traders do. You set your trade a week before, because you know there will be a rally up to this, it’s an obvious trade. The earnings come in and they are great! Perfect Company Ltd rallies by 2% on the day and another 2% the day after. On the 3rd day the global stock market reacts to bad news (recently this has been a global virus or trade negotiations between the USA and China). Or maybe just your sector reacts to any kind of bad news report. Your stock falls to below the buy price. You hang on, things deteriorate and next week your 10% stop loss gets hit and you’ve lost money. On the 3rd week the markets realise that all the fuss was about nothing, Perfect Company Ltd goes on to rally for the next 2 weeks and you could have made 10% profit, but you didn’t you lost 10%. Some might say this is bad trading, others might say you’re unlucky, but the point is this happened, and it will happen. When trading on margin and with accumulating fees, you simply can’t always hang on and hope that the markets bounce bank. Companies do go into administration; markets do fall for months and even years (see bear markets).
Many top traders and gamblers say in their books that you should never risk more than 2% of your entire bankroll on one trade. However, when you look at sites like IG Index many minimums are £1 per point. Many shares are trading at 1,000 points and some far higher. Even with stop losses (not guaranteed ones, although often they sit far lower than you would have liked due to restrictions), you should really consider your risk at £1000 in these trades. Even if we say your average risk is approximately just £100 (1,0000 pts at £1 a point with a 10% stop loss), then you’ll need to have a £5,000 spread account to take your risk per trade to 2%. For many of us, especially beginners that is just not going to be the case.
Money management also becomes harder with spread betting when it comes to leverage, which means you borrow money to take on a bigger position. In spread betting you place your trades in a leveraged position. Different spread betting platforms have different margin rates , however the European Securities and Markets Authority (ESMA) introduced a new tighter margin rule in 2018. An example of this can be seen on IG Index with Apple you currently only need to have a 20% margin which gives you 5:1 leverage. That means that you could earn or lose 5 times as much for every point move than you could if you were to buy shares in Apple. For index trackers like FTSE100 the margin is 5% giving 20 times leverage. This leads us to…..
You can lose more that your account balance.
This is very possible, there are a few reasons, particularly if you have overnight positions and the market opens very differently to how it closes. If the market moves suddenly against you, it is possible to not have enough money in your account to cover the position. It is likely your position will close at the earliest possible time and you will get a message or a call from the broker. The new margin rules make this less likely to happen, but it still could, particularly with volatile markets.
Using stop losses, slippage & gapping.
Stop loses can be a great way to protect your money. If going long (buying) you can set a stop loss at a point that if the stock goes against you it will automatically sell. If you want out automatically at a target price if the price goes up, this is a limit.
The big issue here is that it is not guaranteed. With a stop loss the exit is at the best available price. (Although you can pay a premium with some platforms for a guaranteed stop loss, but this is just more fees!) This can mean if the stock falls suddenly you might be subject to slippage. This is when the price you requested does not match the price executed.
An even bigger problem is gapping. This occurs when the market jumps up or down in price and there is no trading within that price region. Markets can open the day significantly differently to how they closed. This happened to us with a pharmaceutical stock. Out of trading hours they announced that their drug had failed approval. It had closed the previous day at 36 cents a share and re-opened the next day at 9 cents a share. That’s a 75% loss! And on a leveraged product that could be catastrophic. Luckily for us it was a tiny and very cautious position, so the losses were small.
Psychology/A Gambling Mentality.
People have written whole books on this subject, so it’s quite a big topic! Unfortunately, when it comes to trading and investing, being human can be a big disadvantage.
This is particularly apparent after a loss. We tend to want to make our money back quickly and take extra risk, betting bigger and betting on trades we usually wouldn’t have. In poker this is called going ‘Full Tilt’ and it applies to spread betting. A professional trader should treat all trades separately and ignore previous losses, but that’s easier said than done. The best traders have practically no emotional attachment to their trades, which is a tough thing to achieve.
Other psychological behaviours that can affect the way we trade are ‘the bandwagon effect’, ‘loss aversion’, ‘the disposition effect’, ‘emotional & expectation bias’s’ to name but a few.
A final thought….
Spread betting and trading is a very time-consuming activity. Even if you win at spread betting, there are a couple of arguments as to why a long term buy and hold strategy could still be a better option. 2 negatives of spread betting are that you are never going to be fully invested and you don’t get dividends, but this is another debate to be had.