New limits on leverage

Incoming European rules will crack down on spread betting, says Matthew Partridge.


Bitcoin: soon to be harder to trade
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Incoming European rules will crack down on spread betting.

In December 2016, the City regulator, the Financial Conduct Authority (FCA), proposed sweeping changes to the rules on spread betting, with a particular focus on reducing the amount of leverage (borrowed money) that individuals could use to trade markets. This generated a furious response from both punters and firms, as well as threats to relocate to friendlier parts of Europe. However, before anything could be acted on, the European regulator the European Securities and Markets Authority (Esma) launched an inquiry too. In response, the FCA suspended its own, while reserving the right to take it up again if it felt that Esma hadn't gone far enough.

Having published draft proposals in December, Esma has now published the actual regulations, and it's safe to say that the FCA is unlikely to object. Some of the rules make a lot of sense. We've often argued that binary options (bets on whether a currency pair or index will close above or below a certain level) are poor value, and have attracted scammers. So, it's good that Esma wants to ban the sale, marketing or distribution of binaries to ordinary investors. It also makes sense for them to ban special incentives, introduce a special risk warning, and to ban accounts with negative balances, limiting losses.

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Esma has also backed away from earlier proposals to impose a margin close-out rule (whereby a trade is closed automatically once it has lost a certain amount) on a position-by-position basis. This could have left investors in the bizarre situation where they would have had to close losing trades, even if their overall accounts were in profit, thus rendering perfectly valid strategies (such as long/short equity positions and paired currency trades) impossible. This has been replaced with a 50% margin close-out rule on a per-account basis.

The proposals on leverage are fairly draconian however. Esma has essentially taken the FCA's proposals for inexperienced investors and applied them to everyone. The limit of 30:1 (3.33%) leverage for major foreign currency pairs is more liberal than the FCA's 25:1 (4%), but in all other respects they are near-identical. So those who want to bet on individual shares will be limited to 5:1 (20%). And if you want to trade bitcoin, you will have to put up 50% as margin.

The rules kick in later this year. In all, they will limit losses but also gains for most spread betters, especially those with smaller amounts of capital. While it makes sense for the high-risk nature of spread betting to be highlighted forcefully by regulators, recognition of varying experience levels could have been more proportionate.

Trading techniques: what use is analysis?

As well as looking at price movements, and following short-sellers, one way to judge sentiment is to look at the research put out by banks and brokers. Generally "sell-side" research has a poor reputation. This is because, up until the start of this year when new reforms came in, clients hadn't paid for it directly, but received it in exchange for using a particular broker to buy and sell shares. However, some traders argue that, even if the analysts aren't very good, enough people take notice of the research for it to become a self-fulfilling prophecy.

A 2007 study by Valentyn Panchenko of the University of Amsterdam, looking at large-cap US stocks between 1997 and 2003, found that broker upgrades significantly lifted prices on the day the upgrades took place. Conversely broker downgrades immediately hit returns. The effect was stronger when stocks were upgraded and downgraded by several brokers at the same time. However, most of the effects (positive or negative) disappeared in subsequent days so unless you had prior knowledge of what the brokers planned to do, it wasn't of much practical use.

In the longer run, however, analyst recommendations seem to be good contrarian indicators. J Randall Woolridge of Pennsylvania State University found that between 1993 and 2002 the average stock tipped by the largest 15 brokers in the US lagged the S&P 500. A similar study by Cornell's Susan Krische and Charles Lee in 2000 agreed that analysts' tips subsequently underperform, though Krische says that this is mainly due to their preference for recommending stocks with high price/earnings ratios.

How my tipsare doing

It's been a pretty good fortnight for this column's tips. Up until recently, shopping centre operator Hammerson was one of the laggards of our portfolio. Indeed, we were seriously tempted to close our position in it. However, a takeover bid from French company Klpierre has seen its share price soar to 534p. This means the position is now £172 in the black. Indeed, all five of our long positions are now making profits, with oil giant Petrobras, spread-betting company IG Group and car maker Renault making profits of £730, £477 and £505 respectively. Semiconductor group Micron has fallen back a little, but the position is still £177 in profit.

Our short positions are also doing well. After appearing to rally a bit, cryptocurrency bitcoin is now at $7,886, its lowest level for several weeks, and far below the $11,225 it was when we first suggested you start shorting it. At £0.25 per $1 this works out at a profit of £834. Trump's decision to launch a trade war has hit the S&P 500, pushing it below the level at which we suggested you start shorting it, meaning that our S&P 500 short is making a tidy profit of £375.

So in all, our long positions are £1,784 in profit while our short positions are making £1,209 that works out at a total of £3,170. If you then deduct the £1,014 in losses from closed trades so far, this gives us a profit of £2,156 in just over a year (not counting dividends or interest charges).

So what should we do with our trades now? I'm going to stick with them all for the time being and I won't add any new ones yet, but I am going to adjust some of the stop-losses, in order to lock in some of our profits. So, I'm going to increase the stop on Hammerson to 510p, and the stop on Micron to $38; while reducing the stop-losses on bitcoin to 11,000 and the S&P 500 to 2,800.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri