There are solid reasons for spread trading futures rather than trading in the cash market. Lets have a look.
Leverage
We can spread bet with a lot less capital than investing in the cash market. A trade can be set up using a fraction of that required for investing in the cash market. The following example will highlight the how leverage can help you start spread trading online with a relatively little money.
An example whould help. In may you decide to invest in 1000 Green King (the brewer) shares. When you buy they are 200 pence each, so your total trade costs £2000 (before commission). In july, two months later, you sell the shares for 260 pence per share. Giving you a nice profit of 60 pence times 1000. That’s a profit of £600. A very nice profit of over a quarter of the money invested in just 2 months.
Let’s compare the situation when spread betting the futures contract price for the same share. Say we buy (make an up bet) of £10 per point, or, £10 for every one pence move in the share price. The spread betting company will ask you to deposit a ‘margin’ as security for this trade. You could expect the margin required to be about £260.
In our futures trading scenario what happens after we hold the trade for two months, compared to holding the shares in the cash market? First the price is slightly higher to take into account the spread (also their would be a premium for buying a future but that is ignored here). So the price is 204 pence. Contracts shouldbe available for expiry in the following month and 3 months after that. Futures are priced in quarterly intervals. The further away the future date of expiry the higher the premium will be above the cash price.
Every trade is made using a stop loss. This method of managing risk is described in the spread trading guide. At first the stop loss is always set at below the entry price, e.g. 194 pence. Lets assume in this trade we only want to risk £10. So if the price drops by 10 pence our stop loss closes the trade at 194 pence.
The price rises as it did with the cash market example. For every increase we increase our stop loss level. Eventually the Reuters share price drops back and hits our stop loss at 260 pence per share.
The result is bought for 204 and sold at 260. That’s 56 points. At £10 per point we have made £560. Compared to the profit made in the cash market this is slightly less. But….we have only committed £250 of our trading capital rather than £2000. This leaves the remaining £1750 left for making more trades!
This multiplier effect is the magic of using spread betting for online futures trading.
Trading the futures market using spread betting also means you can use much smaller amounts. Some spread betting companies will allow you to use as little at £1 per point for your financial spread betting.