The holy grail for anyone looking to trade is understanding how to make a profit. The big banks have just finished their reporting season and in many instances we’ve seen that the doom and gloom of last year is now slipping away, so how do their traders manage to make their profits – and what can we learn from this? Below we outline four ‘golden rules’ that could offer some insights to successful trading.
1) Always understand your market. A range of fundamental factors will have the potential to move the price of an asset and it is always useful to be aware of these. As an example, a change in interest rate policy can impact exchange rates whilst earnings news will directly influence a company’s share price. If you’re looking for a longer term trade, you should give some thought to just how volatile the market can get while you have an open position and either adjust your stop loss accordingly – or perhaps close out the trade for a day or two.
Example: Legal and General came out with half year results on Tuesday 4th August. The share price quickly plummeted over 12% as traders reacted to news of a dividend cut and a 92% slide in profits for the first six months but a rebound followed in an hour or so as the detail was digested, leaving the stock little changed over the first half of the week.
2) Don’t spreadbet in the short term. Investment banks don’t make the bulk of their money buying and selling on a minute-by-minute basis for a 1p or 2p profit each time, but rather by taking a considered opinion on where markets will move in the longer term. Although frequent trading may present some small profits, the temptation to panic and cash out too quickly has the potential to significantly limit returns. Many people are initially put off trading because they can’t sit their and watch the screen all day – but you don’t have to. If a longer term view is taken on a market and risk management tools such as stop-losses are used, there is no need to fret about what is happening second by second and this can end up being a far more disciplined, stress free approach to the markets
Example: The FTSE-100 will move up and down in rapid succession over the course of the day, but will tend to trend in the longer term. The index is currently sitting 1200 points – or over 30% higher – than its March lows. This shows the erratic price movements on a minute by minute basis and with this comes the potential to realise only small parts of any rally.
3) Understand your risk and spread bet accordingly. Risk management is important in any trading strategy and especially when you are using a leveraged product such as spread betting. When you place a trade, you should also decide where to take your profits and where you are comfortable to walk away from a losing position.
Example: On July 17th the British Airways share price reached 140p for the first time in over a month. Confident that the stock was undervalued and that support would now be seen for the business, you open a spread betting account, place £250 on deposit and buy at £10/point. This means, for each 1p the share price rises, you profit by £10 and for each 1p the share price falls, you lose £10. The share is now trading at 160p, so you should be holding a £200 profit (£10/point multiplied by the 20 point movement), less financing charges which on this trade would run to around £3 but the share did trade lower towards the end of July. Whilst taking advantage of the leverage available from trading derivatives, you should also ensure that you have an adequate buffer or cash cushion in place to prevent any open positions being stopped out. In the above example, trading £10/point on a £250 deposit would generally be considered high risk and a smaller position would be a more prudent way to try and ensure profit in the longer term. Even at £1/point, the above scenario would have given close on an 8% return on the £250 initial deposit over a three week period.
4) Diversify. Don’t put all your eggs in one basket – create a portfolio that will offer you the opportunity to have exposure to a range of different assets. Again this is core to any prudent investment strategy and rather than putting your faith in the fortunes of a single instrument, a degree of diversification is incredibly useful. It is worth being mindful of the constraints above – don’t diversify so far that you cannot keep track of the fundamentals – but looking to make a return from maybe 5 or 10 different instruments means that even if you pick a few bad apples, you still have a fighting chance of realizing some profit. One of the beauties of trading markets using spread betting is you have access to a wide range of different assets: shares/commodities/currencies etc directly from one account, making it very easy to spread your risk and monitor any open trades.
Remember that financial spread betting is a leveraged product and can result in losses that exceed your initial deposit. Spread betting may not be suitable for everyone, so please ensure that you fully understand the risks involved.
For more information on spread betting visit IG Index.
Disclaimer – No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. The research does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. IG Index is authorized and regulated by the Financial Services Authority (FSA No: 114059).
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