Good morning,
Today seemed to be a fitting day to update my global outlook for the stock markets, as yesterday the President of the European Central Bank (ECB) Mario Draghi confirmed that he was prepared for a stimulus program if he felt that the European economy needed it.
This combined with the end of the US stimulus program and the rekindling of the Japanese stimulus program is the symbolic equivalent of the baton being passed on from one continent to the next.
Realistically, I don't think that the markets are likely to go into a long term bearish stage for a while yet, when there's simply too much stimulus in the background coupled with the idea that Richard Farleigh presented in his book "Taming The Lion" that markets have a general tendency significantly over-extend the point people expect them to reverse at.
Further to this, worries of deflationary pressure across Europe in particular are only going to increase the pressure on the ECB to provide a strong stimulus program to counteract these worries.
Potential Trades Assuming ECB Stimulus:
1. The Euro and Yen are likely to suffer from further weakness against their major currency pairs, so there's the potential for a good short position on the Euro or Yen.
2. Long positions in European stock futures would be sensible as the ECB purchases drive down yields elsewhere in the markets (bonds, etc).
3. Shorting gold and silver further is also a trade that will likely yield some pretty good results, but it's worth noting that the extent to which gold and silver have fallen so far makes the next set of support levels a lot stronger in relative terms against its previous levels.
4. Short Dollar denominated assets, which could be pretty much any commodity of your choice, but being careful to recognise seasonal patterns in the soft commodities and industrial changes and production variations in the hard commodities.
5. Short European bond yields, which are going to be under pressure as a result of the purchase of the underlying asset by the ECB.
- This trade has to be done very carefully, because in the US Treasury Bond yields haven't always responded in kind to this trend - probably because the market associates stimulus programs with inflation, which normally causes increases in nominal bond yields.
6. Short non-US companies that depend on the import and processing of dollar denominated goods. If we assume that the dollar is likely to experience a period of medium term upwards price pressure, then companies that purchase or import dollar denominated assets are going to experience greater currency based risk.
- This being said, the very largest companies are likely to have FOREX Swaps in place to hedge this risk, so the medium to smaller end of the market would be better to look at for targets.
Enjoy,
The Masked Stock Trader
Friday, 7 November 2014
Thursday, 6 November 2014
Quindell - Loan Agreement + What Is A Repo?
Aside from being just a great idea (in my opinion at least), the real real beauty of Quindell's RNS on 5th of November is that it allows me to kill two bird with one stone and cover this loan agreement and also a description of the Repo market.
I can cover both of these in the same context, because the loan agreement is effectively a Repo:
What is a Repo?
Effectively, the market for a Repo is a glorified version of the pawnbroking market.
So, as a pawnbroker would take my (hypothetical I might add) Rolex as collateral against a £3,000 loan, large companies and institutions can use securities as collateral against borrowing.
Cash
------------------>
Repo Provider Borrower
<------------------
Securities
Before this agreement is taken out, the Repo Provider will assess whether the value of the securities they're getting is significant enough to fully collateralise the loan. If they don't think this, then something called a "haircut" is put in place, which is when they will ask for more than the value oft he loan to be posted in securities terms to hedge against the securities falling in value and exposing the provider at the other end of the trade.
When this then comes to an end, the "repurchasing" aspect of the Repo, is the when the borrower returns the cash along with the repo rate (the interest - you can't borrow money for free).
Now, it's worth pointing out that a repo can also work the other way around as well, meaning that cash can be swapped for securities - usually to settle short selling obligations, etc.
The somewhat secretive Repo market has gotten people into trouble before and all of this came out in the wash in the 2008 financial crisis, which uncovered the now famous accounting tricks, like "Repo 105".
In basic terms, the accounting reference to Repo 105 because famous when it transpired that Lehman Brothers had been using it to flatter their balance sheet and make it appear that a significant proportion of its debts had vanished. This was because they realised that with high grade securities the haircuts on a Repo were very small, but most importantly that if they posted to the Repo Provider more in securities than the value of the cash they were receiving they could count these transactions as sales on their balance sheet.
Companies have also gotten in trouble for an insufficiently hedged arbitraging processes in the Repo market, with one example being MF Global, who arbitraged the difference between the interest received on bonds and the interest from the Repo involving those bonds, which was fine until the bonds began to fall in value and the Repo was called in.
The Case With Quindell:
Three directors of Quindell, Robert Terry, Laurence Moorse and Steve Scott have effectively signed a repo agreement, in that they can use their shares as collateral against a cash loan, which they can then use to purchase more shares with.
They have the ability to post up to 51,959,658 shares to Equities First Holdings LLC and then at the end of the loan agreement the directors are required to collect their shares:
"To fund the acquisition of shares the Purchasing Directors have each entered into a loan facility that may result in the transfer of up to 51,959,658 Ordinary Shares as security. The Purchasing Directors are each required to redeem the transferred shares at maturity when the loan is repaid at the end of the two year term and it is their full intention to do so."
Contrary to some of the (dare I say it?) "Moronic" posts on certain bulletin boards regarding this deal, Equities First are contractually prohibited from short selling or voting with the collateralised shares:
"Under the terms of the facility, the lender is contractually prohibited from short selling or voting the transferred shares during the term of the loan."
The really good point about this deal, in my opinion, is that it retains the cashflow Quindell, but without adding company related debt - this is a deal between the three directors, not the company.
More Detail:
1. The Haircut of The Deal:
- The haircut of the deal seems to be made pretty clear in the point below, taken from the November 10th RNS (33%):
"in return for the Purchasing Directors receiving a payment from EFH of a sum equal to 67 per cent of the three-day average market value per share less a financing arrangement fee of 3 per cent."
- It's worth pointing out that generally, the nature of these contracts is that if the collateral significantly decreases in value either more collateral needs to be put up against the loan or the loan itself is called in. The haircut itself exists in order to prevent this becoming an issue.
- In the case of Quindell, Equities First Holdings are contractually unable to sell the repo agreed shares - information clarified in the November 10th RNS:
"In entering into the sale and repurchase agreements to provide finance, each of us Purchasing Directors relied upon assurances from EFH that, notwithstanding EFH's legal rights, the custom and practice of EFH was that the shares transferred would not be disposed of outright, other than in a default event and will be held by their custodians throughout the term of the agreement"
All the best,
The Masked Stock Trader (once the Masked AIM Trader)
I can cover both of these in the same context, because the loan agreement is effectively a Repo:
What is a Repo?
Effectively, the market for a Repo is a glorified version of the pawnbroking market.
So, as a pawnbroker would take my (hypothetical I might add) Rolex as collateral against a £3,000 loan, large companies and institutions can use securities as collateral against borrowing.
Cash
------------------>
Repo Provider Borrower
<------------------
Securities
Before this agreement is taken out, the Repo Provider will assess whether the value of the securities they're getting is significant enough to fully collateralise the loan. If they don't think this, then something called a "haircut" is put in place, which is when they will ask for more than the value oft he loan to be posted in securities terms to hedge against the securities falling in value and exposing the provider at the other end of the trade.
When this then comes to an end, the "repurchasing" aspect of the Repo, is the when the borrower returns the cash along with the repo rate (the interest - you can't borrow money for free).
Now, it's worth pointing out that a repo can also work the other way around as well, meaning that cash can be swapped for securities - usually to settle short selling obligations, etc.
The somewhat secretive Repo market has gotten people into trouble before and all of this came out in the wash in the 2008 financial crisis, which uncovered the now famous accounting tricks, like "Repo 105".
In basic terms, the accounting reference to Repo 105 because famous when it transpired that Lehman Brothers had been using it to flatter their balance sheet and make it appear that a significant proportion of its debts had vanished. This was because they realised that with high grade securities the haircuts on a Repo were very small, but most importantly that if they posted to the Repo Provider more in securities than the value of the cash they were receiving they could count these transactions as sales on their balance sheet.
Companies have also gotten in trouble for an insufficiently hedged arbitraging processes in the Repo market, with one example being MF Global, who arbitraged the difference between the interest received on bonds and the interest from the Repo involving those bonds, which was fine until the bonds began to fall in value and the Repo was called in.
The Case With Quindell:
Three directors of Quindell, Robert Terry, Laurence Moorse and Steve Scott have effectively signed a repo agreement, in that they can use their shares as collateral against a cash loan, which they can then use to purchase more shares with.
They have the ability to post up to 51,959,658 shares to Equities First Holdings LLC and then at the end of the loan agreement the directors are required to collect their shares:
"To fund the acquisition of shares the Purchasing Directors have each entered into a loan facility that may result in the transfer of up to 51,959,658 Ordinary Shares as security. The Purchasing Directors are each required to redeem the transferred shares at maturity when the loan is repaid at the end of the two year term and it is their full intention to do so."
Contrary to some of the (dare I say it?) "Moronic" posts on certain bulletin boards regarding this deal, Equities First are contractually prohibited from short selling or voting with the collateralised shares:
"Under the terms of the facility, the lender is contractually prohibited from short selling or voting the transferred shares during the term of the loan."
The really good point about this deal, in my opinion, is that it retains the cashflow Quindell, but without adding company related debt - this is a deal between the three directors, not the company.
More Detail:
1. The Haircut of The Deal:
- The haircut of the deal seems to be made pretty clear in the point below, taken from the November 10th RNS (33%):
"in return for the Purchasing Directors receiving a payment from EFH of a sum equal to 67 per cent of the three-day average market value per share less a financing arrangement fee of 3 per cent."
- It's worth pointing out that generally, the nature of these contracts is that if the collateral significantly decreases in value either more collateral needs to be put up against the loan or the loan itself is called in. The haircut itself exists in order to prevent this becoming an issue.
- In the case of Quindell, Equities First Holdings are contractually unable to sell the repo agreed shares - information clarified in the November 10th RNS:
"In entering into the sale and repurchase agreements to provide finance, each of us Purchasing Directors relied upon assurances from EFH that, notwithstanding EFH's legal rights, the custom and practice of EFH was that the shares transferred would not be disposed of outright, other than in a default event and will be held by their custodians throughout the term of the agreement"
All the best,
The Masked Stock Trader (once the Masked AIM Trader)
Wednesday, 5 November 2014
What Are Clearing Houses?
Effectively a clearing house is a body that guarantees large contracts for buying securities and can also help to reduce costs for large financial institutions at the same time. They also have a part to play in encouraging people to trade on the stock exchange, by putting some security behind the anonymity and stopping deals going awry.
Now, most retail investors like me aren't going to be allowed to become members - we trade too little and don't want to pay the fees. Also the entire criteria are pretty strict in order to reduce their exposure to risk.
The big point regarding clearing houses is that they reduce something called "settlement risk", which is the idea that when you buy shares the details on the register needs to be changed (this is where we get T+3 contracts, etc). Now, doing this there is an inherent risk that something may go wrong and that one of the buyers of shares may not pay up, so the clearing house comes in and guarantees these large orders.
We only tend to hear about them when something goes wrong and the best way to understand them is to pretend that we're a broker:
1. We have lots of orders coming in for the stock XYZ.
2. To save money on commission costs to the London Stock Exchange (LSE) we aggregate (group) these orders.
3. We look for a place to do our big aggregated trade.
4. So we go to the stock exchange and put our big order through.
5. As soon as the deal is struck at the stock exchange, the clearing house comes in and guarantee our large order.
- So if the seller doesn't deliver the shares promised, the clearing house will.
- If the buyer doesn't produce the cash required on the correct day, the clearing house will.
6. There is a process that comes in here, which is that of reregistering the assets legally (usually electronically, by companies like Euro CREST), but in terms of understanding the main role of a clearing house, you can stop at point 5.
The way in which this works in raw terms is simply that the clearing house steps in-between the buyer and seller and asks for a deposit (known as margin). This is normally not very large, 10% being a good ball park figure. This then varies depending on what you're trading, so in late 2011 when there was a lot of worry in the market regarding Italian government bonds, the upfront margins required increased, in order to hedge risk for the clearing houses.
All the best,
The Masked Stock Trader
Tuesday, 4 November 2014
Quindell - Pseudo-Automatic Market Makers and Algorithms
Good evening,
I've discussed before my ardent love for Quindell plc, so I'm going to put that to one side and focus on a short selling strategy that the likes of Roble S.L and others could well be using to manipulate the market and increase their profit potential.
I actually discussed the concept of Automatic Market Makers in a post from this morning that can be found here for those interested and this leads nicely on from that:
http://themaskedstocktrader.blogspot.co.uk/2014/11/what-are-market-makers.html
As I said in that post, Automatic Market Makers (AMMs) are part and parcel of the world of High Frequency Trading (HFT) and are effectively used to force large orders that have split up and put through via algorithms to execute towards the higher end of the price ranges sent by the algorithm in question.
My theory regarding Quindell is that parties with major short interests are performing biweekly "rinse and repeat" procedures on the stock, in part through the use of preventative orders (refilling the order book with sells after significant purchases to prevent the SETS system from ticking up the share price substantially), but also via the use of pseudo-AMMs.
With having a sort of pseudo-AMM in place (I'm calling it a "pseudo-AMM", because it's not actually used in the market making process in this case, but operates on the same principals), institutions with a short interest in the company could take advantage of the third party showing of trades and increase their profitability:
Trades are reported to the stock exchange accurately as buys or sells, but the third party platforms that many people use take the trades and the spreads through the day, to come up with an assumed buy or sell reading depending on the price of that trade and its position within the bid/ask spread at that point.
By using some form of pseudo-AMM, large institutions can ping back and forth to make sure that their "real" buy trades are filled at prices that fit the mid point or below of the spread, thus making them appear as sells, or unknown trades to the majority of retail investors.
Combined with filling the bid side of the order book to cause downwards pricing pressure, this allows the three following points:
1. The subtle accumulation of large numbers of shares through split algorithmic orders (being on the other side to an AMM, as it were).
2. The accumulation of shares within price ranges that misrepresent their real status in the order book.
3. The suppression of the share price and thus the demoralisation of retail investors.
Food for thought...
The Masked Stock Trader
I've discussed before my ardent love for Quindell plc, so I'm going to put that to one side and focus on a short selling strategy that the likes of Roble S.L and others could well be using to manipulate the market and increase their profit potential.
I actually discussed the concept of Automatic Market Makers in a post from this morning that can be found here for those interested and this leads nicely on from that:
http://themaskedstocktrader.blogspot.co.uk/2014/11/what-are-market-makers.html
As I said in that post, Automatic Market Makers (AMMs) are part and parcel of the world of High Frequency Trading (HFT) and are effectively used to force large orders that have split up and put through via algorithms to execute towards the higher end of the price ranges sent by the algorithm in question.
My theory regarding Quindell is that parties with major short interests are performing biweekly "rinse and repeat" procedures on the stock, in part through the use of preventative orders (refilling the order book with sells after significant purchases to prevent the SETS system from ticking up the share price substantially), but also via the use of pseudo-AMMs.
With having a sort of pseudo-AMM in place (I'm calling it a "pseudo-AMM", because it's not actually used in the market making process in this case, but operates on the same principals), institutions with a short interest in the company could take advantage of the third party showing of trades and increase their profitability:
Trades are reported to the stock exchange accurately as buys or sells, but the third party platforms that many people use take the trades and the spreads through the day, to come up with an assumed buy or sell reading depending on the price of that trade and its position within the bid/ask spread at that point.
By using some form of pseudo-AMM, large institutions can ping back and forth to make sure that their "real" buy trades are filled at prices that fit the mid point or below of the spread, thus making them appear as sells, or unknown trades to the majority of retail investors.
Combined with filling the bid side of the order book to cause downwards pricing pressure, this allows the three following points:
1. The subtle accumulation of large numbers of shares through split algorithmic orders (being on the other side to an AMM, as it were).
2. The accumulation of shares within price ranges that misrepresent their real status in the order book.
3. The suppression of the share price and thus the demoralisation of retail investors.
Food for thought...
The Masked Stock Trader
What are Market Makers?
Good morning,
Rather conveniently, answering this question also answers the question of "Why can most people always be able to trade in financial markets?" - selling shares is not the same as selling your house, which can take forever depending on what price you're asking for it.
In effect, the job of market makers is to provide liquidity (the ability to buy and sell) and you'll find them in basically every market (currencies and bonds, etc). The big point about the stock market though is that the exchanges want to encourage as much trading as possible and thus want a market continuously running.
Generally speaking large banks and one or two hefty brokerage firms will have teams who act as market makers (primary traders).
Now, market makers make money though the bid/offer spreads, with larger spreads meaning more profit for the market maker. Incidentally, stocks that have more market makers in a particular stock will usually have smaller spreads and market makers are technically obliged to give two-way prices at all times:
e.g.
Bid = 10p
Offer/Ask =12p
Spread = 2p or 20%
Bid: This is the price you sell at to the market maker (the price they buy from you at).
Offer/Ask: This is the price you buy at from the market maker (the price they sell to you at).
If you get confused as to which price you buy and sell at, remember that the market maker's job is to screw you over for as much money as possible, which should remind you that you buy shares at the offer/ask (the higher price) and sell at the bid (the lower price).
Most market making in terms of daily volume on exchanges is actually done by electronic market makers, which are then overseen by primary traders, like the SETS system that runs on the London Stock Exchange and is effectively an electronic order book for the share you want to trade in.
This has a rather cool link to high frequency trading (HFT), because automatic market makers exist within the HTF market to try and get the highest price available from someone looking to buy shares:
e.g. I want to buy 1000 shares in BP at 440p.
Now, I could show my hand and just put that into the electronic order book, or I could get an algorithm to split that order up into groups of 100 shares, with a cap to not buy at a price above 440p.
In the next step, the Automatic Market Maker starts to realise that these 100 share buy orders are coming in and try to take advantage of this, so it starts to ping out orders in descending ask prices and then immediately cancel them until something comes back positive.
When the order hits the 440p mark the Automatic Market Maker will come back with an ask price that's been accepted. Then the Automatic Market Maker will go out and buy as many shares as possible, so to then sell these to me at 440p per share. Trying to buy shares, I can't then go anywhere else because the Automatic Market Maker has pulled all the shares towards itself within that price range, leaving me to purchase at 440p per share.
Thereby, the Automatic Market mMaker can manipulate the price of certain stocks to the upper range of an algorithms price strategy.
Have a great day,
The Masked Stock Trader
Rather conveniently, answering this question also answers the question of "Why can most people always be able to trade in financial markets?" - selling shares is not the same as selling your house, which can take forever depending on what price you're asking for it.
In effect, the job of market makers is to provide liquidity (the ability to buy and sell) and you'll find them in basically every market (currencies and bonds, etc). The big point about the stock market though is that the exchanges want to encourage as much trading as possible and thus want a market continuously running.
Generally speaking large banks and one or two hefty brokerage firms will have teams who act as market makers (primary traders).
Now, market makers make money though the bid/offer spreads, with larger spreads meaning more profit for the market maker. Incidentally, stocks that have more market makers in a particular stock will usually have smaller spreads and market makers are technically obliged to give two-way prices at all times:
e.g.
Bid = 10p
Offer/Ask =12p
Spread = 2p or 20%
Bid: This is the price you sell at to the market maker (the price they buy from you at).
Offer/Ask: This is the price you buy at from the market maker (the price they sell to you at).
If you get confused as to which price you buy and sell at, remember that the market maker's job is to screw you over for as much money as possible, which should remind you that you buy shares at the offer/ask (the higher price) and sell at the bid (the lower price).
Most market making in terms of daily volume on exchanges is actually done by electronic market makers, which are then overseen by primary traders, like the SETS system that runs on the London Stock Exchange and is effectively an electronic order book for the share you want to trade in.
This has a rather cool link to high frequency trading (HFT), because automatic market makers exist within the HTF market to try and get the highest price available from someone looking to buy shares:
e.g. I want to buy 1000 shares in BP at 440p.
Now, I could show my hand and just put that into the electronic order book, or I could get an algorithm to split that order up into groups of 100 shares, with a cap to not buy at a price above 440p.
In the next step, the Automatic Market Maker starts to realise that these 100 share buy orders are coming in and try to take advantage of this, so it starts to ping out orders in descending ask prices and then immediately cancel them until something comes back positive.
When the order hits the 440p mark the Automatic Market Maker will come back with an ask price that's been accepted. Then the Automatic Market Maker will go out and buy as many shares as possible, so to then sell these to me at 440p per share. Trying to buy shares, I can't then go anywhere else because the Automatic Market Maker has pulled all the shares towards itself within that price range, leaving me to purchase at 440p per share.
Thereby, the Automatic Market mMaker can manipulate the price of certain stocks to the upper range of an algorithms price strategy.
Have a great day,
The Masked Stock Trader
Monday, 3 November 2014
Quindell plc - The Week's Technical Analysis
Good morning,
Over the past couple of weeks we've seen some more decent signs of recovery from Quindell:
1. Roble's short interest has fallen from 4.46% to 4.28%.
2. The 130p support line has so far held on the daily chart (excluding the slight dip below on the close of October 15th), with the next major support line being at around 105p - a support line that originated from around 2012 and that was
3. On 31st October we saw a 100,000 share buy from the non-execturive director Robert Bright.
Technical Analysis:
There are some pretty decent arguments for why technical analysis is irrelevant in the case of Quindell and many of these I agree strongly with - algorithmic share price suppression with structured intra-daily buy backs, etc.
I think that the promising sign here is what looks to be a slightly lopsided inverse head and shoulders pattern forming (September 26th being the left shoulder, October 15th and 16th being the head and with the right shoulder looking to be formed at around 130p), which is a bullish reversal pattern.
For this to be confirmed, we would really need to see a rise from around 130p to 180 or above.
Using my Slow Stochastic Oscillator, it looks like we need to see K and D settle at around 11 before we can make a good much up, but comfortingly there does seem to be a gradual, rising stochastic trend-line in the lows of the indicator since late September, which is a promising sign that we're due a leg up soon. It's notable that since the Gotham City attack all technical indicators work better if you take them outside of their usual extreme zones (i.e. your usual stochastic range from 20-80 changes to 10-90).
I've found that the RSI, CCI and MACD that I would usually use for extra input to have been significantly delayed in the case of Quindell, thus making them somewhat redundant.
The only other indicator that has been any real use since the Gotham City attack has been that of my fibonacci moving averages (not something normal people use, because they don't carry the same emotional responses in the market that say a 200 day moving average does).
They're pretty good at calling reversals, and to pick some recent examples you could have used them to call reversals in early August, late September/early October and in mid October:
Currently, if we assume that the 130p daily support line will hold, then it makes logical sense that these should begin to turn soon for another leg up. In the event that this line doesn't hold, then we could be waiting a little while longer for another leg to the upside.
All the best,
The Masked Stock Trader
Over the past couple of weeks we've seen some more decent signs of recovery from Quindell:
1. Roble's short interest has fallen from 4.46% to 4.28%.
2. The 130p support line has so far held on the daily chart (excluding the slight dip below on the close of October 15th), with the next major support line being at around 105p - a support line that originated from around 2012 and that was
3. On 31st October we saw a 100,000 share buy from the non-execturive director Robert Bright.
Technical Analysis:
There are some pretty decent arguments for why technical analysis is irrelevant in the case of Quindell and many of these I agree strongly with - algorithmic share price suppression with structured intra-daily buy backs, etc.
I think that the promising sign here is what looks to be a slightly lopsided inverse head and shoulders pattern forming (September 26th being the left shoulder, October 15th and 16th being the head and with the right shoulder looking to be formed at around 130p), which is a bullish reversal pattern.
For this to be confirmed, we would really need to see a rise from around 130p to 180 or above.
Using my Slow Stochastic Oscillator, it looks like we need to see K and D settle at around 11 before we can make a good much up, but comfortingly there does seem to be a gradual, rising stochastic trend-line in the lows of the indicator since late September, which is a promising sign that we're due a leg up soon. It's notable that since the Gotham City attack all technical indicators work better if you take them outside of their usual extreme zones (i.e. your usual stochastic range from 20-80 changes to 10-90).
I've found that the RSI, CCI and MACD that I would usually use for extra input to have been significantly delayed in the case of Quindell, thus making them somewhat redundant.
The only other indicator that has been any real use since the Gotham City attack has been that of my fibonacci moving averages (not something normal people use, because they don't carry the same emotional responses in the market that say a 200 day moving average does).
They're pretty good at calling reversals, and to pick some recent examples you could have used them to call reversals in early August, late September/early October and in mid October:
Currently, if we assume that the 130p daily support line will hold, then it makes logical sense that these should begin to turn soon for another leg up. In the event that this line doesn't hold, then we could be waiting a little while longer for another leg to the upside.
All the best,
The Masked Stock Trader
Sunday, 2 November 2014
What is Spread Betting?
Good morning,
The best way to understand spread betting is to compare it to trading shares in the usual fashion of buying the physical asset (not trading price derivatives):
Buying shares the usual way works like this (ignoring spreads, stamp duty and potential taxes and charges):
The best way to understand spread betting is to compare it to trading shares in the usual fashion of buying the physical asset (not trading price derivatives):
Buying shares the usual way works like this (ignoring spreads, stamp duty and potential taxes and charges):
- I want to buy 1000 shares in The Masked AIM Trader plc
- The share price is £2.00
- 1000*2.00 =£2,000 - I've purchased £2,000 worth of shares (or exposure)
Now, let's say that the share price rises to £2.50:
- I sell all 1000 of my shares
- 1000*2.50 =£2500
- So, my profit =£2500-2000
- Profit =£500
A spread betting example:
In a spread bet, you place certain amount of money on the "per point" movement in an asset's price. A point isn't a standardised number and often brokers will recognise them differently, but in this case let's assume that 1 point is equal to 1p.
The term "spread bet" suggests that there are two prices (just like in trading physical shares) - one to make an up/long bet and one to make a down/short bet, but to make the example easier to follow, we're going to ignore this for the moment and assume that you could buy and sell the bet at the same price.
- I want to bet £10 per point on The Masked AIM Trader plc rising in price
- The current share price is £2.00
- My broker will look at this bet and say that it's the equivalent to someone buying 1000 shares in the usual fashion.
- He or she will then take a percentage of this would-be total cost (in this case 5%) and keep it in a separate account until the profits or losses are settled up
- The deposit my broker takes is therefore 5% of £2000 =£100
- I decide to close my bet at a price of £2.50 (I sell my "buy"/"long" bet)
- My profit will equal the amount of points that price has moved by (50) multiplied by my bet per point (£10)
- Profit= 50*£10.00 =£500
As in the first example, I've made a nice £500 profit and in this spread bet I also made £500 profit, but there are some really handy advantages to spread bets over trading physical shares.
Advantages of Spread Betting:
- You don't have to pay any stamp duty.
- You don't have to pay capital gains tax on any profits.
- You can leverage your investments (you don't need to pay the full amount upfront).
- You tend not to have to pay commissions to open and close positions.
- You can open short positions much more easily than most private investors trading physical shares usually can.
Disadvantages of Spread Betting:
- The main disadvantage with spread betting is that you've got to be prepared to fund your losses in the event that the position goes against you (a margin call).
- One way around this is to have a guaranteed stop loss in place, which will mean that your broker will guarantee you an exit price if the trade goes against you. They tend to be more expensive than a standard stop order, so expect a wider initial spread on your bet, but they don't come with the risks that usual stop losses have (being triggered significantly below the stop price, etc) and will act as a good form of risk management.
Enjoy,
The Masked AIM Trader
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