Losing money is never the goal of anyone investing in the stock market. Every single trader who spread bets on a share to rise or fall hopes that eventually the price will go the way they expect, and that they will be able to close the trade at a profit.
Having said that, there are very real stock market trading risks involved in every single trade. Below we will briefly outline what those risks are and how a trader can minimise their effects.
The biggest risk facing a trader is that the stock he or she is trading in will decline in value during a ‘long trade’ or increase in value during a ‘short trade’, especially when using a leveraged product like spread betting.
When one looks at the performance of a group of stocks, e.g. the FTSE 100 stocks, over a period of time, a trend often emerges. Price movements often form what is called a ‘normal’ distribution, with a majority of small movements and a minority of large movements during a specific time period.
Trading a stock market index is often considered to be less risky than trading an individual stock as it represents the combined value of a range of stocks. While chances are relatively small that the FTSE 100 will move 10% during any 24 hour period, it can easily happen in the case of some individual stocks.
To minimise the risks of trading in an individual share, it is generally thought to be safer to spread your portfolio over a number of shares.
While past performance cannot be used with any certainty to predict future price movements of one or a group of shares, investors often use it as a guide when picking the shares they want to trade in.
Many traders will tell you that the best way to minimise trading risk is to ‘trade with the trend’. By this they mean that you should use some sort of technical indicator to try and determine the current market trend and then trade in that direction.
A popular Japanese chart system, the Ichimoku Kinko Hyo, provides a clear visual indication of whether the market is currently in a trend or not.
This system has been used with a reasonable measure of success by many longer term traders. It does not, however, provide a guarantee that the price of a stock will continue with its current trend. The risk of a sudden about-turn caused by unforeseen economic, financial or even political circumstances will always face investors in any market.
One way of reducing your potential risks when spread betting is to add a stop loss to your trade.
A stop loss is an order to close your trade if the market moves against you and reaches a predetermined level. One thing to note is that not all stop losses are guaranteed; if the market were to move sharply and gap over your stop loss level then your trade would be closed at the next traded price.
Some spread betting companies also offer guaranteed stop losses. These stop losses come with a small charge, normally in the form of a wider spread, but your trade is guaranteed to be closed at the level you requested even if the market gaps over it.
For many traders, the trick with a stop loss is not to set it too narrow, you should allow the market to breathe, to go about its normal ups and downs even while it follows a certain trend.
Setting it too wide, on the other hand, will expose you to losses which your trading account might not be able to absorb. Always remember that capital preservation is of the utmost importance to any trader.
Spread betting is a leveraged investment option, it involves a high level of risk to your funds and can result in losses that are greater than your initial investment. Please ensure that spread betting matches your trading objectives as it might not be suitable for all investors. Ensure that you only spread bet with capital you can afford to lose. Make sure you fully appreciate the risks involved and request independent advice where you feel it is necessary.
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