Folio Management | Spread Betting: Risk Management - A Pilot Study

26th Jul '20 by William K

14 comments 831 reads

Spread betting: Risk management – a pilot study

Introduction

Although I am mainly a conventional buy-and-hold investor, the prospect of changes to capital gains tax (CGT) mean that I may need to move my non-ISA funds into a spread betting account to avoid losing income. (Currently a married couple can make £24,600 per annum tax free on capital gains.) The proceeds of spread betting are not taxable and highly unlikely to become taxable. It seemed sensible to conduct a trial of a risk management strategy for spread betting, using real money to test the psychological as well as mathematical challenge. As Minervini has suggested, it is necessary to rehearse with real money, using enough for the losses to hurt, but not enough to wipe out one’s account.

Method

Between 31^st May 2020 and 14^th July 2020 (45 days) I lay 38 bets using a momentum-breakout strategy based only on price action. Each bet was worth, on average, about a £1000 investment in the shares with a stop loss giving a 10% maximum loss (around £100).

Shares were sold when they hit the stop loss or earlier if they seemed to be moving fast in the wrong direction within the first couple of days. The study lacked academic rigour as I used some discretion over the entry and exit points of each trade.

Results

There were 11 winning bets and 27 losing bets.

The cost of spreads was about £5 per trade (0.5%) - total cost £190.

The winning bets averaged 9.6% profit and the losing bets averaged 5.7% loss (including all trading costs).

The total won was £1037 and the total lost was £1538 giving a net loss of £501 (1.3%) on a portfolio worth a nominal £38,000.

Overall the sold losing shares would have gained an additional £844 in total if I hadn’t sold them, whilst the winning shares would have lost a further £33 (0.3%) in total if I hadn’t sold them.

If I had not sold any winning or losing shares, the portfolio would have been worth £38,313 on 26^th July 2020, a net profit of £313 (0.8%) – this equates to an annualised return of around 6%.

Conclusions

I need to do a lot of work on my entry and exit strategy for each trade before using serious money, in particular I need to standardise everything.
My trades would probably do better if I set the stop…

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Gromley

26th Jul '20

Interesting thought Wilkonz,

My initial observation though would be that you are conflating three separate concepts :

1. The mechanism you choose to place your "bets" on the future performance of a company's share-price.

2. The fundamental reason (small f) and timescale on which you "bet" on a company's share-price.

3. Whether you apply "leverage" (ie borrow to invest, on the basis that you expect your investment retrurns t o exceed your "cost of capital".)

I absolutely understand the tax free benefit of spread-betting. In fact it is a major reason that I use Spread-Bets.

I don't think that I qualify as a "buy and hold" investor, but my average holding time (guessing - I haven't actually analysed it) is probably 2-3 years.

I have three categories of investment vehicle :

1. ISAs

2. Ordinary Share Accounts

3. Spreadbets

(This will become 4 when I onboard my pension into SIPPs)

But I make exactly the same investment approach whichever vehicle I use.

The relative benefits / disbenefits are :

1. ISAs : No tax, cheaper than Spreadbets.

2. Ordinary Share Account - Cheaper than Spreadbets, but taxbale gains.

3. Spreadbets : No tax. if ISA allowance is used up then no limit to how much can be invested (tax free). Dis-benfits : More costly : the "spread" is based on the "official" spread plus a benefit for the SB provider (with options 1 or 2, you can often buy within the spread). You also endure an ongoing cost (by one way or another) of continuing to hold a position over a longer period.)

In relation to the cost of Spreadbets, this is related to position size. Spreadbets tend to be cheaper for very small positions (the crossover normally seems to be c. 1-2k). Unexpectedly, this can actually support more conservative investing by allowing smaller investors to become more diversified.

There are also two separate 'advantages' that I personally consider, but I deliberately excluded above because they are where SpreadBets invoke extra risk :

1. The ability to apply leverage - "ie to invest more capital than I actually have". (If you do not want to apply leverage it is easy to stump up the 5,10,20% margin required for your 'bet' and keep the rest in a savings account.)

2. An easy avenue to shorting. My stance for the last few years has been to be as close to "market neutral" as possible, I do tiny shorts (many of them). Big conviction shorts are more like gambling and I don't do these.

So my question has to be :

Do you want to shift from being an investor to being a trader or do you want to reduce your tax bill by 'exploiting' spread bets?

You can do BOTH if you wish, but you can also do either of them independently.

Mike888

Rather than increasing the size of your stop from 10% to 12%, which from a risk management perspective is probably not so much about risk management and more about trying to stay in the game, consider setting your stop on a combination of technical support and the amount you are willing to lose. This will also influence your position size.

I spread bet and also buy and sell conventionally too. Regardless of which method I use to enter the market my criteria are exactly the same. Although risks are magnified by leverage, and as such you need to manage your positions more closely, I think it a mistake to change your investing style as by doing so you are compromising everything you have learnt in the markets. The only reason to change your investment methods is if you are moving from investing to trading, trading requires a different skill set and a double digit stop would probably not best suit this approach.

As Gromley has said, leverage on derivatives is there to take or not, and having a cash balance elsewhere reduces leverage. I've always found it a little annoying that SB brokers don't consider a cash balance to reduce overnight charges.

Macro

My observations:

1. You did quite well! If on average 90% of account holders lose 90% of their funds within 90 days, then you did quite well. Rejoice!

2. If the Government end ISAs how do they expect to be re-elected by retail investors? If they normalise CGT and Income Tax levels - how do they expect to be re-elected by small business owners?

3. If in normal times the 'right' trailing stop-loss level on a FTSE 100 stock is between 15% and 20% then why would it be lower for a spread-bet? Given that we are not in normal times and that Volatilty remains elevated (i.e. VIX is ~25 rather than between 10 and 16) why would a lower stop loss level be appropriate - all other things being equal?

4. Given that most people trading with leverage seek to (a) minimise market risk through a mix of longs and shorts (b) seek out technical entries that minimise risk and so maximise reward / risk .... things are definately not equal! i.e. you cannot translate an buy and hold investor mindset to a leveraged account (unless you have deep enough pockets to withstand drawdowns multiplied by the gearing factor).

dustyie

27th Jul '20

Hi , just my thoughts on switching to spread bettting to avoid tax is flaw , spread betting is financial instrument that cost approx 3% interest yearly. So just for you positions to break even you holding will have to increase by approx. 3% yearly , not to talk of the probably approx.1% extra spread .

In shares account ... what shares you buy is critical and the timing is probably less critical as you wait that be bit longer for the return on your money , if timing is out

with SB account you share selection skill is also critical and the timing skill is also of equal importance (time is an cost factor )

I treat my spread betting account like my betting account. (it money i can afford to lose )

for me, there is a big psychology game with spread betting , Know that time cost money will influence my trading skills in a negative way.

I wish you well with spread betting , it an enjoyable game for me when the sums of money are small.

William K

Macro. Many thanks. Useful points. With regard to tax, we have a government that needs to get a lot of revenue fast. If, in the process, they upset a few retail investors and small businesses, that isn't going to bother them unduly because these people aren't likely to vote Labour in the next election.

Thanks Gromley. I agree with your points, which is why I am considering spread betting as an alternative to buying and holding for the purpose of limiting tax bills - rather like an extension of my ISA. I have no intention of changing my b&h strategy for my ISA. There is no reason why one cannot be both an effective 'buy-and-holder' and a spread bettor - after all it's possible to be a good cricketer and footballer. With regard to costing of bets, I tend to bet on US companies which have much smaller spreads than UK companies, particularly if you trade large ones like Apple and Microsoft. The spreads can be as small as 0.1%, which means in effect you can buy and sell £10K of these companies fora £10 trading cost without incurring FX charges. (A similar buy and sell on HL would incur £24 for two commissions plus £200 for two lots of FX at 1%. This equates to 2.24% and would take nearly a quarter of a 10% profit.)

Thanks Mike888. Useful insights. For me the main differences between investing and spread betting/trading are:

1. Time scale - years vs. days/weeks/months

2. Types of stocks - 'safe' tracker funds/large caps vs. high risk/high momentum smaller caps.

3. Investing - no stop loss. Trading - stop loss essential.

4. No leverage vs. leverage

And yes it is annoying that spread bettors get no recognition for the cash on deposit in the account.

"A few retail investors": In 2018-19 there were 11.2M _new_ adult ISA subscriptions in the UK. 76% of those were Cash ISAs (8.512M). The rest were _new_ Stocks and Shares ISAs (2.688M).
At the last election the electorare was 46.6M, of whom 67.3% voted (31.34M). The Conservative vote share was 43.6% (13.66M). Suddenly 2.688M votes does not seem so unimportant? By comparison only ~28,000 per annum estates pay inheritance tax. Rasising tax is problematic for those that need to be re-elected. Somehow taxes need to be raised whilst attempting to minimise the number of 'victims', especially when those people are predominantly your own voters.

28th Jul '20

Thanks Macro. Useful statistics. And I'd be the first to agree the government cannot afford to lose 2.6 million votes - although if they did lose those votes, would they automatically go to a party with a policy of punitive taxation for the relatively prosperous? It is not the people with ISAs who need to worry about increases in Capital Gains Tax (CGT). Unless the government is daft enough to abolish tax relief on money held within ISAs, which is improbable. I was thinking of retail investors hoping to make significant income in the form of Capital Gains outside their ISAs - this figure I'd guess is closer to the 28,000 per annum of deceased who qualify for inheritance tax. The government has very few areas left in which to raise taxes (many tax rises have the net effect of reducing tax revenue as people just spend less money on non-essentials) and Rishi Sunak is 'looking at' CGT - he may well increase the level from 20% (or 28% on property) to 40 or 45% in line with upper tax bands. He may also remove or reduce the tax free allowance of £12,300 per person. If he does this, a retired married couple could see an immediate drop of £10K in their annual income.

Hmmm. So if one deducts 3.5-4% from a total win of 10% the net effect is nearly as bad as paying 40% CGT. Thanks for pointing that out. I'll need to aim at about a 14% profit to make spread betting cost effective. That's going to be quite a challenge... but I'll work on it.

jwebster

Taxes.

The big pots left to go at are property and pensions. Suspect these will be introduced labeled as a 'wealth tax' such that the tax kicks in above a certain threshold. This will raise money while avoiding upsetting their voting base. France has something like this. The trip wire is capital flight and if the public finances get too bad expect capital controls. Remember the UK has twin deficits. Seems improbable but if you are invested in Sterling assets for the long term it's a scenario to consider, especially if you plan to eventually retire abroad.

Spreadbet vs share accounts. I use both. Long term holds and small caps (as large spreads) in share dealing accounts, I use IG as you can place orders on L2 and work within the spread for small caps. Shorter term mid-large caps and overseas stocks in spreadbet accounts - tighter spreads especially on US stocks and no FX charges or stamp duty. But pay an overnight interest charge on long positions in a spreadbet account.

If you hold a long share position in a spreadbet account and it pays a dividend, you get a credit wrapped within the account. They have to do this to prevent a capital loss of course, but it means you still 'get' the dividend. Also you avoid the headache of dividend withholding tax.

HumourMe

And I'd be the first to agree the government cannot afford to lose 2.6 million votes - although if they did lose those votes, would they automatically go to a party with a policy of punitive taxation for the relatively prosperous

That is an interesting question many of the people excluded from the CJRS (Furlough) or SEISS (Self employed) are asking themselves. Figures vary but are estimated to be between 1m-3m households affected. It has led to the largest All Party Action Group in history. The Treasury select committee has asked questions. Rishi Sunak though is focused on looking forward. He has to be congratulated for politically mobilising so many, however, it may come back to bite him the next time there is a chance to vote, or when it finally dawns on people that their furloughed job is going down as their employer wasn't supported. Then the numbers really begin to swell. Strangely the £10 meal voucher doesn't seem to have gone down well with those affected.

Metatron

Been spreadbetting for 17 years and use it now for bitcoin,foreign shares,seasonal trades,shorting and the VIX.
I look for overbought & oversold entry points.
The VIX went up 600% earlier this year and along with shorts is a way of insuring your normal long portfolio.
Bitcoin frequently moves 25% either way in a week.
Over the 17 years most years i have lost overall however i have had a couple of big winning years and touch wood this year is on course to be a good one.You need a bankroll to cover at least 8 losing successive trades

Spread betting: Risk management - a pilot study

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William K

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