I get a big kick out of trading. It’s risky. It’s self-indulgent. But it’s a riot when it works out – I am always on the look out for the next opportunity.
Recently in Right Side I’ve been writing more and more about these opportunities. We’ve looked at how to make money from trading the FTSE 100 as she bounces around in a frenzy. And it’s worked out well.
If you followed my recent trades, you’ll be sitting on some handsome gains. The recent short on the FTSE paid off, banking another 100 points.
But I know that this sort of trading isn’t for everyone. It certainly isn’t my mainstay either. And with the FTSE trades, I may have gone in at the deep end – I saw an opportunity and just blurted it out, hoping you’d be interested in the ride.
Today I’d like to take a deep breath and take the time to add a bit of context to these trading ideas.
Let’s think about what differentiates trading from investment. Then we can see what we’re looking for in a trade, and how you can get set up to profit from it.
Are you a trader or an investor?
The way I see it, there are two major differences between trading and investment.
First is time frame. Trading looks for a short-term gain. Traders may only hold a position for a matter of minutes. In fact one of my favourite City jokes is “What do you call a trade that’s gone wrong?” Answer: “An investment.”
And there’s more than a grain of truth in that. A bad trader won’t accept a loss – so they’ll sit on the position, hoping to get back to break-even some day.
Secondly there’s the riskiness of the transaction – we’re talking about volatility here. It’s what puts off many private investors from trading. And frankly, that’s fair enough. There is no doubt that careless trading can lose you your money (and sometimes more) very quickly.
But I think there’s a home for trading for most of us. If you have a plan and stick to it, there’s money to be made. More than that, you can learn an awful lot of useful stuff from trading strategies – stuff that’s invaluable for your long-term investing too.
What you’re looking for in a trade
Let’s deal with volatility first. We need the share, or index to bounce around a bit. That’s why I advocated trading the FTSE now. I wanted to make the most of her volatility. Sure it’s a little risky. Global events mean that the market is bounding both up and down – but that offers opportunities.
To harness volatility you need a strategy – that way you can use it to your advantage. Buy low, sell high is the crux of my recent trade – simple, but effective.
If you can harness volatility and get her onside, then she can be a great ally. It allows us to get in and out quick.
The second thing we’re looking for is small transaction costs. Of course we’re always looking to minimise slippage. But with trading it’s even more important. Take our recent FTSE trade. We looked to make 100 points each time the FTSE dipped up and down. And with the FTSE at around 6000, a hundred point move was about 2%.
Now just imagine trying to pocket 2% moves on something like a small cap stock. You’d get skinned alive! The spread (the market makers commission) on small caps can easily be 5%. The trade simply wouldn’t work.
And that’s just the spread. Once you’ve added on broker commissions, trading on anything that has a high spread is a no-no.
So the question is: How can you keep dealing costs and spreads to a minimum?
My favourite way to trade
I use spread betting to carry out most of my short-term trading. And I know spread betting carries an air of gambling. I guess the clue is in the name. But to avoid this platform because of the name could be a mistake.
For short-term trading there are some great benefits here. For starters there are no commissions – so even if you want to place a small bet, you can do so without suffering over-sized fees. Sure, you’ll have to pay the ‘spread’ but generally that’s small. With bets there’s no stamp duty – and better still, there’s no tax on your profits.
With the FTSE 100, I pay one point on the spread. That’s less than 0.02%. The standard bet rolls over at the end every day so you end up having to pay the ‘spread’ each day. That’s effectively the cost of financing your bet. But, given that we’re looking at short-term trading, then I think you’ll agree, it’s not an onerous cost.
You have to watch out for spreads though. Don’t go using a spreadbet to punt on small cap stocks – you’ll end up paying a big spread. And then when it comes to roll-over you pay again (though usually at a lower rate).
Spread betting can offer significant gearing. A small deposit can give you large exposure. But remember, this can be dangerous. You can actually end up losing more money than you put in. Whenever dealing with a margin product, it pays to play it carefully.
There are other low cost options for trading. For instance contracts for difference (CFDs) which I’m going to cover in a later edition of The Right Side. And if you’re dealing in size (and regularly) you may even find that an online brokerage account can still be cost efficient.
For instance if you wanted to trade the FTSE 100, you could use an exchange-traded fund (ETF) through your standard broker. As there’s no stamp duty on ETFs and spreads are minimal on the highly traded ones, overall transaction costs can be as low as 0.2%. I think that’s still a lot compared to what we get from the spread bet.
If you want to read about more trading techniques and ideas, then why not sign up to my colleague John Burford’s free email – MoneyWeek Trader.
I like John’s regular email and it’s a great way to familiarise yourself with spreadbetting techniques.
• This article was first published in the free investment email The Right side. Sign up to The Right Side here.
Important Information
Your capital is at risk when you invest in shares – you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Spread betting is not suitable for everyone – ensure you fully understand the risks involved and never risk more than you can afford to lose. Spread betting carries a high level of risk to your capital. Prices can move rapidly against you and resulting losses may be more than your original stake or deposit. Margin amounts vary between spread betting companies and the type of markets spread bet.
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