Spread betting offers considerable advantages over share trading for active and experienced investors.
Traditional share trading requires one to purchase shares on a per unit basis. In other words if you were considering buying shares of XYZ company which are trading at £10 per share and you were to purchase 100 shares, then your initial outlay would cost you £1000 which is simply £10 X 100, £10 for every share that you owned.
When trading on margin you are able to purchase more stock with less capital. This is called leverage. Margin acts as a deposit to cover any potential losses that you may incur while holding a spread bet position. If the Margin requirement is set at 10% then you will be required to place 10% of the value of your trade as a deposit. Thus a 10% margin of a £1000 trade equates to a £100 deposit. Therefore to place this deal you are only placing a fraction of the value of the trade as a deposit.. Quite simply you are able to increase your profits using a much smaller capital base.
So when purchasing shares in the traditional manner you are required to have the full amount of capital available before you buy the shares compared to margin trading, where you are only required to have a percentage of the total amount as a deposit.
The advantages of margin trading
The most obvious advantage of margin trading is that one can trade using less capital than conventional methods of investing. Also, whilst using a portion of your investment capital for margin trading the remainder can be placed in an interest bearing account.
Because spread betting is a leveraged product, with brokers you are only required to deposit a fraction of the full value of the product you are considering trading. Margin requirements can vary typically between 1% to 10%. These can of course vary depending on the volatility of the chosen product.
The risk of margin trading
Although margin trading can be favorable if used correctly, there are also disadvantages in trading on margin.
If a position is opened and goes against your desired direction, losses can be magnified. Even a small bet size can turn into a big loss if the trade is not managed appropriately. One also needs to implement correct money management in order to benefit from margin trading.
Therefore it is essential that one understands the risks that accompany leveraged trading.
An example of a margin trade
Let’s now take a look at a trade example using spread betting and as to how margin requirements are calculated.
For each trade you open you will be required to deposit (or have available in your account) funds to cover a proportion of the bet which is known as the Margin Requirement. This is simply a deposit in order to open a spread bet. The margin will usually be a percentage of the notional value (or total value) of your trade.
The Normal Margin Requirement (NMR) is the minimum amount of funds required to open a position without a Stop Loss attached.
The Minimum Margin Requirement (MMR) is the minimum amount of funds required to open a new position with a Stop Loss attached.
You Buy £10 of Vodafone at 190p.
The spread betting provider have set the Normal Margin Requirement of Vodafone at 10%.
The provider will calculate the margin required in the following way:
(Price x Margin) x Stake = Margin Required
Margin Required – (190p x 10%) x £10 = £190
If you buy £10 per point (or ‘per penny’) of Vodafone at 190p you would need to deposit or have £190 available in your Trading Resources to cover this trade.
Note: Each market has its own margin rate, even amongst individual shares. The margin rate may change dramatically (for instance where the price volatility of an equity has increased substantially). Please refer to the market information sheets for the margin rates on all our instruments.