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Spread betting margins made easy

Created:
25 November 2005
Written by:
Dan Oakey

One of the most common mistakes made by novice spread betters is to confuse 'initial' margin with 'variable' margin. On an individual trade, you may need to put down 1, 5, 10, or 20 per cent of your total exposure. The exact level will vary depending on the underlying stock - for example, you can open a spread bet on an index with a much smaller margin than you can with a volatile FTSE 350 stock. That's the initial margin.

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But as soon as the markets begin to move, a second margin comes into play. If you took a long position on, say, the FTSE 100, and the index falls, you begin to owe the spread better money. Until you close the trade, these losses are still paper. Even so, they will be set against your initial deposit to work out your variable margin.

How spread betters calculate margin

Suppose the FTSE 100 keeps falling. What happens next depends on which spread better you use. Some firms, such as Capital Spreads attach an automatic stop-loss to every position that you open. If the FTSE 100 falls beneath that stop-loss, your position will be closed. The default stop-loss level will never be so far away that all of your initial margin is lost. Some firms calculate margin on a position-by-position basis, even though they do not insist on stop-losses.

Other companies, such as IG Index, agree on a limit with the client when opening an account. At the smaller end of the client spectrum, a margin call will be triggered once your position is losing you £500. IG will contact you by e-mail or telephone to request that you deposit more funds to enable you to keep your position open or close the trade at a loss.

For bigger clients, though, with more conspicuous evidence of funds, the margin rules are less onerous.

If you have several trades open at one time, some spread betters will amalgamate them in order to calculate your total exposure. That way, even if one trade is going badly wrong, you will not need to pay in extra funds provided your other trades have done well enough to compensate. However, this kind of 'orders aware' margining can trip you up, unless you understand the details of the formula used.

For example, firms differ over how much you can offset trades. With IG, you can offset a long position on the FTSE with a short position on the Dow. This extra level of sophistication is sensible, given the high correlation between the two indices. IG will also allow you to go long and short of the same underlying at the same time, if you want.

One complication that sometimes catches people out is the degree of 'concentration' in your positions.

As Roger Hambury of City Index explains: "A concentration limit is when a client has one stock in his portfolio and it is viewed that the position is taking up all of his margin. The risk then is a lot greater than if he had five stocks using all his margin. The clearer may then set a concentration limit. For example, if he has one stock using all his margin and that stock has a margin requirement of 25 per cent, the clearer may raise the margin requirement to 50 per cent or higher."

There are two other points to remember. First, just because you can use margin, it doesn't mean that you have to. One of the most common mistakes novice spread betters make is to overstretch themselves. A few bad trades later, they have wiped out their capital and have to retire to lick their wounds.

Secondly, the more you use stop-losses, the greater the margin you can trade on. This is because the spread better knows that there is a safety mechanism in place.

Credit accounts

One of the more alarming things you can do when you open a spread betting account is to borrow thousands of pounds from your spread better. In theory, you can then trade on a double margin: you put down only £5,000 to gain exposure to a £50,000 trade, but that initial stake is itself borrowed money.

But in reality, the spread-betting companies that offer credit accounts - IG Index, Cantor, City Index, Finspreads and Man Spread Trading - take a more responsible approach.

Most of these firms have been in the spread-betting market for a long time and are careful to distinguish between rookie clients and experienced customers.

"We need to be comfortable that the client understands risk and financial markets," says IG's Dan Moczulski. They also need to see evidence of your funds.

The golden rule is that you should never take up the offer of credit if you lack the funds to trade. The credit accounts are designed for the convenience of wealthy clients who want to move in and out of positions very quickly. In the time it can take to transfer money from a bank account to the spread-betting account, trading opportunities can pass you by. That should be the sole reason to use credit from a spread better.

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