Advantages of Leverage in Spread Betting
When it comes to leverage, it would be wrong to think that the picture is wholly one of doom and gloom. While recognising, understanding and tackling the risks of leveraged trading is one of the most important elements of developing a successful spread betting trading style, you should also be aware that leverage can work in your favour, and can be a particularly useful tool in helping you take the next step up the ladder in your trading career. All too often, treatments of leverage start by looking at all the advantages, to enthuse the trader and captivate the imagination, while in reality a more balanced summation of the positives and negatives is needed to paint a more accurate reflection.
The drawbacks of leverage aside, the leverage built in to spread betting transactions means that fundamentally insignificant market movements can in fact deliver substantial returns to a position. In spread betting, the degree of leverage is such that the slightest of movements in either direction can make or break a position – this is partially what makes spread betting so attractive. If you buy shares in a FTSE 100 company, you are likely to wait years before you can see any substantial capital increase on that position because companies don’t tend to deliver returns to shareholders that match the volatility and leveraged returns afforded by spread betting. With financial spread betting, the rate of return and crucially the speed of return, which enables the effects of compounding gains, is vastly increased, which allows more freedom for traders to explore other trading opportunities.
Advantage 1: Improved Rate of Return
Leverage primarily boosts the degree of return you can expect on similar proportional gains in underlying value. A share that increases in value by 10% will deliver a 10% capital increase to a share trader, whereas the same rise on the same share through spread betting would deliver a 1000% return. The rate of return is artificially lifted because of the ‘betting’ angle of spread betting – returns are paid on multiples of your original stake, rather than being tied directly to the underlying value. While in practice this performs the same function as traditional leverage, on a technical note these earnings are distinct, because they are paid by the broker rather than arising from the markets directly.
This is arguably the main advantage of leverage – the ability to earn more money from like transactions through using a leveraged trading mechanism such as spread betting. With no extra effort or cost, and only the additional burden of higher risk to bear, this ultimately helps make spread betting an appealing choice.
Advantage 2: Speed of Return
Correlative to the increased rate of return that is delivered with leveraged transacting, the speed of return is also enhanced by trading through spread betting. In spread betting, incremental movements can return substantial rewards, so there’s no need to invest in a position for the long haul. In fact, because of overnight charges and volatility at market close and open, there are actually significant disadvantages in hanging on to a position for too long. This makes spread betting a fast moving, high trade volume type trading mechanism, deliver faster profits and losses than are seen in the traditional share markets.
The speed of return should not be underestimated as a critical factor in determining your overall profit potential. If you can bag a 2% return on your capital a week, which is highly feasible in spread betting given the speed at which everything takes place, your capital pot will be exponentially larger in a matter of months. This high growth trajectory comes as a result of compounding, and the sooner you start to compound your earnings, the more quickly you will build up some serious trading capital.
Consider this example, in percentage terms. Aiming to increase your trading capital by 2% a week, you start trading with a capital pot of 100%. After week one, assuming all goes to plan, your capital pot is worth 102% of its original starting point. In week two, your target is adjusted to now represent a 2% capital gain on 102% – again, assuming all goes well and your trading strategies pay off, your capital pot will stand at 104.04%. By the time the year is out, you will have almost tripled your money, with your capital standing at over 280% after 52 weeks. This is because you are constantly increasing the capital you have to play with through reinvesting your trading gains. When you imagine these numbers in the context of more adventurous percentage gains on a weekly basis, the sheer force and momentum offered by compounding becomes even more apparent.
The speed at which your earnings compound is an essential determiner in your success as a trader. While not all transactions are linear, and while you will undoubtedly have better days than others in terms of the returns you can generate, the ability to quickly add percentage points to your trading capital is a massive, hidden advantage of spread betting, and one that most traders tend to ignore. Even on a strategy of simply reinvesting marginal gains, you can rapidly build up your portfolio, thanks in no small part to the speed at which leverage allows you to take a profit.