Due to the leverage, financial spread betting can be a high risk activity. You can create large gains but you can also create large losses. This article looks at the differences between standard and limited risk spread betting accounts and how you can manage your maximum loss.
Margin
Before we compare these two types of accounts, we need to look at the concept of margin. Whenever you want to place a spread bet, the spread betting company will only allow you to do so if you have sufficient capital in your account to protect against any likely loss.
If for example, we were buying shares for investment purposes using a standard share dealing broker, we would have to deposit the full value of the instrument that we were buying. In spread betting we do not own the underlying instrument, we are betting on its future price. As a result, we typically only need to deposit a small fraction of the cost of the underlying instrument as margin (typically between five and twenty percent).
Standard Risk Accounts
In a standard risk spread betting account, when we want to place a new bet, the spread betting company will ensure that we have enough capital in our account to cover the margin as described above. If for example we go long on a stock that is valued at 724p at £1 a point and there is a ten percent margin requirement on that instrument, we would need to have £72.40 in our account as margin for that bet. That £72.40 could then not be used as margin on any other bets.
In a standard risk account, you may or may not be required to place a stop loss on your trades. This varies from one spread betting company to another. Let’s say that in the above trade, we place a stop loss at 654p. If we are stopped out we stand to lose £70, which is less than our initial margin. However, the market could gap down through our stop and open anywhere.
Let’s imagine that some particularly bad news comes to light about this company overnight whilst we are in our trade and the stock opens at 602p the following morning. Our stop loss is triggered and we lose £122. We only had to have £72.40 in our account for that trade, but we have lost £122. With standard risk accounts it is possible to lose more than the value of your account. The spread betting company will then be ringing you to deposit further funds to cover your losses.
Limited Risk Accounts
In a limited risk account, you are forced to place guaranteed stop losses on all your trades. Your margin requirements will then reflect your maximum loss and you can never lose more than you expect. With a limited risk account, you will never have the spread betting company calling you to deposit more funds.
Guaranteed stop losses come with a small premium which usually amounts to a few points on each trade. Note that not all spread betting companies offer guaranteed stop losses or limited risk accounts. When they are offered, guaranteed stop losses can usually also be used in standard risk accounts. The major difference between the two accounts is that guaranteed stop losses must be used with limited risk accounts.
Conclusion
If you are just starting out in financial spread betting, then a prudent course of action may be to open a limited risk account. Many of the spread betting companies will offer this account facility and as a new spread better, they will be only too glad to assist. You know that with a limited risk account, you are never going to experience a margin call and you are safe in the knowledge that you will never need to supply more capital into your trading account.