Three ways to reduce spread betting risk

Spread betting is risky. The market can take off suddenly, or crash through the floor - leaving you behind to count your losses. Tim Bennett explains three things you can do to protect your capital.

Spread betting can be risky. So here are three easy ways to limit the potential damage.

Spread watching

Remember that the more obscure the bet, the wider the likely bid-to-offer spread in 'pips' or 'ticks'. Although spreads might be tight on say the biggest forex contracts or the FTSE 100index, they can widen fast in less liquid markets say for house prices or less popular stocks. So always check this before placing a bet or you'll need a huge shift in your chosen bet target to just break even and recover the spread.

Limit orders

When market conditions are volatile (the start of the day is a good example as overnight orders all pile into the market together. Key data releases such as the US non-farm payroll numbers are another) either stay away altogether and wait for things to calm down, or use limit orders. These allow you to place an order at a 'no worse than' price. For a buy order on the FTSE 100, this would be, in effect, an instruction to your broker to "open my up bet but no higher than 5,000 points" [or whichever price you choose]. The downside is your order may never execute, or take a while to do so, but at least you know the price you will trade at.

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The most popular alternative a market order will execute at the current market price with no limit. Practice using both on your broker's simulator before going live.

Stop losses

If you bet on a rising FTSE 100 using a spread bet, your risk is that it subsequently plummets. This might happen while you are in a meeting or playing golf, so you have no way of knowing, let alone stopping your position from racking up losses. Or do you? A stop loss order for which you typically pay a small premium in terms of a slightly wider spread cuts your risk. In effect, it says to your broker "get me out if the market hits x".

One step on is the guaranteed stop. The plain vanilla stop order may not get you out at the price you expect if it is competing with lots of other similar orders. That's a particular risk in volatile periods such as the credit crunch last year. But for a little extra on top, your broker will guarantee to get you out at the price you specify.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.