Many providers offer limited risk accounts to new share traders or inexperienced investors or help them manage their risk, but what is the logic of opening a limited risk spread betting account?
It is possible to make substantial profits when you bet with a spread betting provider, but there is also the danger of substantial losses.
A ‘Limited Risk’ account allows you to put an absolute ceiling on your possible loss without affecting your ability to make potentially unlimited profits. This means that with a limited risk trading account you are safe in the knowledge that you never risk an amount greater than the funds you have in your spread betting account. This is because a guaranteed stop loss is linked to each spread trade to make sure that your losses are kept under control even in cases where the market gaps.
In contrast to normal trading accounts, a Limited Risk Account works by limiting your risk on all your trading positions by placing a Guaranteed Stop Loss Order. This guarantees that you cannot lose an amount bigger than your account balance. Of course a fee applies for placing a guaranteed stop but this way all your trades are stopped at the exact level you specified, irrespective of any market gapping. This gives beginners a greater level of safety and peace of mind of knowing in advance their maximum amount at risk.
Market gapping is a phenomenon where a market opens at a higher or lower level than when it closed on the previous day’s trading session. Thus, while all spread trading accounts have access to standard stops which close out trades at best execution, there is still a risk that the closing price level could differ from the stop loss order level in the event of market gapping.
Controlled Risk Bets
When you open a Controlled Risk bet you specify the level at which you want your bet to be closed, should the market move against you. The spread betting firm will guarantee that your bet will be closed at exactly this price, even if the market moves straight through your level. So there is no danger of losing more than you expected on a big market move.
When you open a bet, tell the dealer you want it to be opened on a Controlled Risk basis. There is an extra charge for this; it is incorporated into the dealing spread, all of which is paid when the bet is opened. No spread is charged when the bet is closed. The best way to understand a Controlled Risk bet is to look at an example.
Note: Even if you do not make a Controlled Risk bet, it is still possible to put a non-guaranteed Stop or Limit Order to your bet. These types of order can be placed to open or close betting positions, and are available free of charge on most non-limited risk bets.
A Controlled Risk Bet on Wall Street
It is April and you believe that Wall Street will fall in the next two months. You check the spread betting company’s quote for June Wall Street. The provider is quoting 11218-11230. You decide to sell GBP15/point – but are keen to limit your risk to a maximum GBP900. The opening price for a Controlled Risk ‘sell’ is the middle of the firm’s quote minus the spread betting provider’s Controlled Risk spread of 16: 11224 – 16 = 11208.
You ‘sell’ GBP15/point at 11208. You have bet GBP15/but only want to risk losing GBP900, so you can only afford the market to go 60 points against you – in this case up to 11268 from 11208.
You put a Controlled Risk Stop at 11268
In the weeks after opening the bet, Wall Street does fall. Do you want to take your profit?
Checking the spread betting company’s June Wall Street price you see they are quoting 11096-11108
The closing price of a Controlled Risk bet is the middle of the provider’s quote – in this case 11102. To close a ‘sell’ bet you ‘buy’ at this price. You ‘buy’ GBP15/point at 11102.
Your profit is calculated as follows:
Opening price: 11208
Closing price: 11102
You win 106 x GBP15 = GBP1590
Your judgement proves faulty as Wall Street rapidly makes gains. One morning the spread betting provider’s is 11286-11298. The middle price of the provider’s quote, 11292, is above your Stop level of 11268.
Your bet is automatically closed at 11268.
Your loss is calculated as follows:
Closing price: 11268
Opening price: 11208
You lose 60 x GBP15 = GBP900
Particularly when you are learning financial spread betting, you might consider a Limited Risk Account. A Limited Risk Account has a guaranteed stop loss
attached to each trade. This comes at an additional cost of a wider spread and there are fewer markets available to trade.
Note: Apart from stops and guaranteed stops there are other trading tools available to help you minimise losses and manage profits, like Limit Orders and Trailing Orders which are designed to close out trades at a price that is better than the present market price level to help lock in gains.