Q. Why did Germany’s ban on short selling cause the markets to fall by so much last week?
A. It is important to note that this decision came at a critical time for the markets. Investors were already feeling incredibly jittery about the European sovereign debt crisis spreading from Greece to other weak economies in the Eurozone. There are a few key issues that Germany’s decision helped to bring to the forefront. First and foremost it became immediately clear that the other European nations had not been consulted or pre-warned of Germany’s intention to install this ban. The main reason that the markets reacted so badly to the news was that the ban sent out a message that there is a great divide among European leaders at a time when investors are looking for Europe to unite in strength to combat the sovereign debt problems affecting Greece and to boost confidence in the markets. But Germany was not the only factor that weighed on markets last week. The passing of a new financial regulation bill in the US Senate has made the market nervous about what impact more regulation could have on corporate profits. When the markets are uncertain investors tend to flee risky assets such as mining or banking stocks and recycle their funds into historical safe haven investments such as the US dollar, gold or bonds, which is exactly what we saw last week.
Q. How can I use spread betting to hedge my portfolio?
A. Many investors do this and it can be a very cost efficient way of reducing the loss your portfolio could incur should equity markets continue to tumble. One way to hedge is to sell off risky assets and buy assets that are regarded as safer by the markets. Spread betting allows you to take short positions with relative ease, which is why it can be a useful hedging tool. You can effectively short sell a portion – or all – of your portfolio in a spread bet, and by doing so hedge your physical portfolio should its value decrease as share prices fall. For example, let’s say you hold £2,000 worth of shares in Rio Tinto, but you are concerned that continued uncertainty may trigger further falls in its share price. You can short sell £2,000 worth of the company’s shares in a spread bet. If Rio’s share price drops further, then you would make a loss in your physical portfolio, however this should be cancelled out by the increase in value of your spread bet position. This is the essence of hedging: one position cancels out the other. Many investors use spread betting to hedge their portfolio when they are about to go on holiday, to help protect its value just in case the markets do fall sharply and they can’t react in time because they are on the beach.