Hedging your spread betting portfolio to limit downsides

ONE of the biggest draws of spread betting is the sheer range of markets that are offered. If it moves, you can put a spread bet on it. But faced with this huge range of markets, there is always the temptation to simply find one sector and stick with it. But prudent investors should approach spread betting the same way that they approach the rest of their investment portfolio, hedging against risk as well as aiming for a diversified portfolio.

According to Angus Campbell, head of sales for London Capital Group, the most popularly traded market amongst clients at the moment is currency. It is interesting that throughout 2010 indices were by far the most popular markets, but now in 2011 they have been pushed into second place. “The majority of clients stick to trading either FTSE or Dow, and on the currency side euro-dollar and sterling-dollar are the most popular pairs, closely followed by dollar-yen.”

“One way of looking at spread betting is your own personal hedge fund. You can trade a variety of markets in both directions using leverage,” says David Jones, chief market strategist at IG Index. “This is a great way of diversifying your trading pot, but you should still pay attention to some basic risk management principles. For example, if you were to buy gold; silver; copper; Antofagasta; Fresnillo – that is not diversification, that is a one way bet on metals still going up.”

Rather than simply gunning for everything in one sector, investors should look instead to gain exposure to a range of things that are not interlinked. The aim is to have investments that are not strongly positively correlated or maybe even negatively correlated so you can hedge against losses elsewhere. For instance, when insurers were hit by the earthquake in Japan earlier this year, construction companies rallied.

HOW MUCH TO RISK
There are no hard and fast rules about how much to risk, and every trader will have their own rules to go by. But the most important thing is not to risk everything on one trading idea. Leveraged trading, such as spread betting, is a marathon, not a sprint. According to David Jones, “most sensible approaches to risk management suggest not risking more than around 3 per cent of your capital on any one trading idea.” This would mean that if you have, for example, a £3,000 account, then if any one idea goes wrong, it should not lose you more than £300. “Whilst this is unexciting and may take you an awful long time to get your lime green Lamborghini, it does ensure you stay in the game if you have a losing period where your trades go against you.”