I met a friend for a couple of beers last night and during the course of our conversation I realised that he knew very little about the advantages of Leveraged Trading over traditional Non-Leveraged Trading. I thought a post with a couple of examples may help.
This example describes how you can use Spread-betting as a way of leveraging your trading;
In both examples I have £3,000 to invest;
An example of a traditional Non-Leveraged Trade.
I'm interested in a stock that is trading at 13p. For my £3,000 I can buy 23,076 shares.
The stock goes to 16p. My investment is now worth £3,692 - A return of 23%
An example of a Leveraged Trade.
Based upon the same example as above. I want to control the same amount of shares in the 13p stock, but I want to use a leveraged product. How would this work?
My leveraged trade needs to 'act' as though I have 23,076 shares. Meaning for every 1p rise my leveraged trade will need to move by £230.76p (23,076 *0.01). So I simply 'go long' (or buy) a spread trade at £230/point. I now effectively control 23,076 shares.
The spread-betting company I use would ask that I deposit £750 in order to open this position (Each spread trading company have differant ways of calculating deposit requirements). The remaining £2,250 I decide to invest in a low risk bond or some other non-corrolated market.
The stock moves to 16p - A 23% gain in the stock price, but a huge 93% on my deposit of £750.
The Risks
Obviously there are risks involved in this type of trading - for example if the stock falls to 1p, in the non-leveraged example all that happens is my investment is now worth £230, whereas in the Leveraged example I would have been asked to deposit more funds in order to cover the loss.
Spread-betting in the UK is not subject to income tax, making it additionally attractive. However is does carry additional risks which do need to be fully understood before it's sensible to start trading in this way.
