Basic concept of leveraging

Lever_Principle_3DSpreadbetting is about leveraging*. In spreadbetting a bet may be  only £1.  What does that mean in real terms?

A share can be worth £50 today on the stock market but on leveraging platforms it may appear as 5000 points (bear in mind that I’m only using the word ‘share’ conveniently because you don’t own anything with spreadbets).

When you buy a single share on the stock market you pay only £50 and that’s it – you own it.

However in spreadbetting for your £1, if price moves 50 pts up to 5050 in the above example, you make 50 x 1 = £50 positive equity.  That’s like saying your one share on the stock market increased from £50.00 to £50.50. You’d have to had purchased, 100 shares at £50.50 on the stock market to make a similar £50 positive gain.

So from this you can see that your £1 is actually ‘buying’ the equivalent of 100 shares. That’s leveraging at it’s simplest i.e. a small movement or force being magnified.

Example 1:

Lets say Athenahealth is on your platform at 11568, then the true price would be say £115.68 (it could be USD  – it matters not which one as we’re not converting dollars. Were just dealing with points).

If you enter a £1 bet to go long (i.e. your expecting price to rise), then your £1 is multiplied per point of rise. So if Athena rises to 11768,  you will have profited £200. [ (11768-11568) x 1 = 200 ]

Now assuming the price is in sterling, you’d have to buy (117.68 – 115.68) x 100 shares on the stock market to make the same gain of £200. But how much does that mean in real money if you were dealing directly on the stock market? Well, your outlay would have been 100 x 115.68 = £11,568!!!

So in effect if you’re looking for a £200 gain in spreadbetting on the above example it’s as good as putting the equivalent of £11,568 into the stock market. However, because of the way spreadbetting is set up (and I don’t know the ins and outs of it), your coverage of the bet is roughly two-tenths of 11,568. Margins vary by the instrument you’re trading. You may need to read up what ‘margin’ means but basically it is portion of your equity to cover the bet.

[I am leaving out a whole bunch of other things like spreads, interests and commissions in the above calculations, only to demonstrate the way leveraging works, in essence.]

Example 2:

EURUSD is at 10350 on your spreadbetting platform. You bet £1, going long. You’re looking for a 100pt move up to 10450, for a profit of £100.

The actual price of the EUR/USD is 1.0350. If you were trading the markets directly, you’d have to buy 10,000 lots and spend 10,000  x 1.0350 = 10,350 (in whichever currency) – which is a lot to put out. Then when price gets to 1.0450, sell i.e. (1.0450 – 1.0350) x 10,000 = £100 in order to make the same £100 if you had done a spreadbet.

I’ve only focused on ‘going long’ but the reverse applies in spreadbetting. On the stockmarkets you can’t make money if your shares depreciate in value, unlike in spreadbetting. Of course, in spreadbetting your losses are magnified in the same way, in whichever direction if price goes against you.

Example 3:

2016_GBPMXNTake GBPMXN. The true retail price is 25.0000 per lot. On a spreadbet platform it may appear as 250000 – and let’s say you entered a £1 bet. If price rises to 252000, that’s 2000 points gain i.e. £2,000 gain. It’s not quite obvious what’s happening here. The last digit from the left, means that a £1 bet is purchasing the equivalent of 10,000 x £25 worth of ‘forex’. You’d have to purchase 10000 at £25 in a raw trading platform and wait for price to rise to 25.2000 for the same effective profit. Your £1 bet is therefore the equivalent of £25 x 10000 = £250,000. Some see the mathematics but still don’t get it or believe it!! Such is the ‘power’ of the human mind; to believe or disbelieve what ever it wants.

Impact

What the above means is not fully appreciated by most traders even though the math is understandable.

1. In Example one: a change of just £2 in share price means 200pts. £2 doesn’t seem a lot but it is very significant. If the market goes the other way your losses are your bet size multiplied by 200!!

2. In defining your acceptable loss and by where you place your stop-loss, you absolutely have to know the size of risk you’re taking on. You cannot treat spreadbetting like the stock-market.

3. Money and risk management become terribly important in the above.

 

*Please note that I’ve over simplified the above only to get the concept across. It may be inaccurate in some ways.

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