Calculating Profit and Loss in Spread Betting
One of the key advantages of spread betting for individual traders is that it represents a much more straightforward transaction than many other investment styles. When looking at the spreads, it is easy to determine how successful your position has been by reference to your original stake amount, such is the degree of ease in reading spread betting transactions. Likewise, on the down side it is possible to quickly and easily calculate your loss at certain market levels - essential in guiding the trader as to the best stops and limits to put in place as part of risk mitigation.
Knowing how to calculate your potential profits and loss from a given transaction is much more than a mathematical bonus. In actual fact, being able to calculate the outcome at given price points is a distinct advantage, and enables you to make trading decisions based on financial forecasts rather than leaving it up to chance. As part of a rationed and logical trading strategy, knowing the arithmetic of your open positions is a vital tool in breeding consistency and ensuring you keep your eye on the ball at all times.
A significant benefit of spread betting is that the arithmetic in calculating winnings and losses is easily done, making it much easier than many alternative investment types to do the maths. The variables you need to know in order to calculate your profit from a transaction are as follows:
Your original buy/sell price: the price at which you bought (or sold, if you're going short) the market.
Your stake: which will be factored in to the calculation as a multiple to deliver your profit portion.
Projected end prices: the price points for which you're looking to calculate your potential profit - e.g. a 1% rise, 2% rise and 5% rise in the market value.
Any other costs: any other commissions or trading costs that must be factored in.
With these variables at your disposal, the calculation becomes a fairly straightforward one, and provided you understand the mechanics of the arithmetic it is something you can calculate mentally without too much trouble.
To start with, take the projected end price you're calculating for and subtract from that your original buy price and any additional trading costs you're factoring in for that transaction. Then, multiply your stake amount by the difference between the original price and the end price to calculate your potential return at a given closing price point.
While in a strict accounting sense you might normally attribute a portion of other costs (such as subscriptions, Internet connection etc.) on a per transaction basis, it's probably best for the ease of calculation that we forget about these cost bases and calculate trading profit.
Here's a quick numerical example of calculating spread betting profits in action.
Your market is priced at 98-102, which you decide to buy at 102 at a stake of £10 per point. You want to calculate your profit if the market rises to 130, with no additional costs to factor in.
(Projected price - (Original price + costs)) x Stake = Profit
(130 - (102 + 0)) x £10 = Profit
28 x £10 = £280 Profit.
Calculating Exposure and Positioning Stops
Remember that when it comes to spread betting, your liability doesn't end when your trading account runs out. It doesn't even end when your bank account runs out - you are personally liable, even though your debts may be incurred online, and the broker will chase you for repayment of the relevant transaction amount. Therefore, it's crucial to make sure you have a firm grasp on your exposure to loss, in order that you can take steps to minimise this liability.
Calculating your potential losses at any given price point is simply the inverse of the profit calculation - by calculating the difference between the buy price and the closing price and multiplying by your stake, you generate the total loss figure at a given price point.
Carrying on the above numerical example, but supposing you want to calculate your loss is the market falls to 76.
(Original price - (Projected price + costs)) x Stake = Loss
(102 - 76) x £10 = Loss
26 x £10 = £260 Loss.
One of the most important tools for spread bettors by far is the stop loss, and being able to calculate your losses quickly off the top of your head allows you to get a better feel for where your stop loss might be placed. It is always advised to use stops to minimise your exposure to risk - the downsides are far outweighed by the positives of having this safeguard in place. By calculating where your limit for losses lies, and on reflection of the behaviour of the given market you're trading, you can better determine how to most effectively reduce your downside exposure.