If you’ve ever googled ‘get rich quick’ (just me?) you’ll be familiar with the articles making bold claims of easily attainable fortunes. ‘Make millions on the markets in 3 easy steps’. It sounds great, it’s enticing, and it’s also too good to be true: unless you’re incredibly lucky, it’s unlikely you’ll be finding your fortune overnight. If you want to make a million on the markets, it pays to take your time.
A couple of years back, lured by the intangible lucre of the foreign exchange markets, I signed up to one of the most popular online trading platforms. But I was naive, I underestimated how unpredictable the markets can be. They’re in constant flux, the values of stocks and currencies rocket and plummeting in the blink of an eye. Sometimes a momentary lag in your wifi connection can spell disaster. There’s no denying that investing your hard-earned cash is a risk. You may not see it again. And I didn’t.
Two years on and I’ve a keener eye. I’ve abandoned fickle forex in exchange for security in stocks. And each week I’ll be documenting my discoveries – the wins, the losses; and hopefully, the low-risk road to that much-sought-after profit.
It’s been a difficult first week. Mistakes have most definitely been made. But I’m learning from them and setting out the rule book. So here are my unbreakable rules:
They may be the markets the trading platforms are really trying to sell to you, and sure you can make big bucks in mere milliseconds, but trust me, unless you seriously know what you are doing (and that means a direct line to inside intel), avoid the foreign exchange markets. Tiny fluctuations in the value of a currency can wipe you out in seconds, and those fluctuations can go in either direction at any given moment. It really is 50-50 unless you’re going in for the long haul, but even then the risks are precariously high.
Start small, grow slow
It’s always important to get to grips with things before you throw all your eggs into the basket. You’ll be hanging that basket from a dangerously high tree, and though I can tell you which branch I’ll be hanging mine from, you can never be certain of which branches are likely to break. Until you have a sense of the risk to your capital, keep your investments low and you’ll soften the blow. And another thing: those ‘virtual trading’ platforms are great at first – use them to figure out your strategy and test it out before you commit. However, putting down your hard-earned cash is an entirely different matter: the decisions we make, the risks that we take… Nothing is quite the same when you’re playing with the real stuff. So though they should play a valuable role in your early days of figuring things out, it’s best to move on to the real stuff as quick as you can and, as said, start small and grow slow.
Diversify your portfolio
You’ll hear this one a lot – in more common terminology it’s called ‘not putting all of one’s eggs in one basket’. When investors talk about diversifying their portfolios, they tend to not only be talking about owing shares in multiple companies, but in companies from a variety of different industries. The logic is clear: invest all of your money in one company, or in a number of companies operating within the same industry, and you’ll stand to lose a lot if things take an unexpected turn for the worse. The wider you spread your portfolio, the safer your money will be; but it’s important not to let this distract you to0 far from the overall objective: to invest in the companies that are most likely to make you money. Investing in a company only for the sake of diversifying your portfolio would be unwise if that company is unlikely to ever make you much profit.
Invest high, leverage low
Leverage is a dicey tool: regardless of how much you’re investing (like I say, start small and grow slow), you’d be well advised to keep those leverages low. You might be pretty certain that a share price will close higher than it opened, but it’s always liable to be a bumpy ride en route and if you over-leverage even the smallest of potholes can knock you below your stop loss and spell disaster. But that’s not to say you should ignore it – leverage will play an important role in your spread-betting enterprise. Why? Because some share prices are high, and some are low. If the price is high, proportionally things aren’t likely to change all that much – that’s when the ability to scale-up your investment becomes an invaluable asset.
I lay out my strategy for using leverage in The Plan below
Not what you’re willing to lose
but how much you expect the market to fluctuate
Now obviously you don’t want your investment to run into losses, and if it does (which will happen more than you might like to believe), you need to be realistic about how much you can afford to lose, but it’s important to set your stop loss high enough to counter price plummets. What do I mean? Here are two graphs to help illustrate. The first shows a share price trend over the course of a single day, noting the price at every hour. If you invested in that share when the markets opened, you’d have a tidy profit by the end of the day. That is, unless you set your stop loss too low. Share prices aren’t declared on the hour and only on the hour – they’re live, they update in real time as people but and sell and the value of the share rises and falls.
Don’t confuse ‘shares to sell’
with ‘shares to avoid’
Most of the largest financial publications are targeted at long-term investors with broad portfolios. Thus, when they advertise a share as one to sell, they aren’t necessarily predicting a likely fall, but rather that the uncertainty in this share’s price ought to encourage anyone currently holding the investment to give it up. Betting on falling share prices can be a valid investment, but beware – a company’s share price is meant to increase as the business grows and the price index rises with inflation… Only bet on a fall if the grounds to do so are sufficiently compelling.
Profit and loss aversion
They say that one of the fundamental characters of a good trader is an understanding of when to cut your losses and when to wait it out. But for most people an instinct for timings takes some time in the making. Loss aversion is when you buy shares, the price drops, you panic, you sell, you lose. Because we’re averse to the idea of losing money on our investments, all-too-often we sell at a loss because we’re afraid of the idea of losing more than we think we already have. But in many cases the price bounces back. There are a number of tools you can use to help when this is likely to happen – using these tools is called ‘technical analysis’.
Less-known and less-acknowledged is profit aversion. As the name suggests, it’s the exact opposite to its lossy counterpart: when you’re running at a profit but are worried about the prospect of losing what you have and so sell long before the share price peaks and lose out on a potentially larger profit. Make sense? Now of course this isn’t the worse thing to have happen – you’re still winning, you’re still quids-in. But though you may be happy with the £10 you won on that scratch card, you’re not going to throw out your lottery ticket before the numbers have been called… Okay, perhaps this isn’t the best analogy (when has anyone ever won anything more than £2 on a scratch card?! How likely is it actually that you’ll then go on to win something even bigger in the lottery?!). But who knows? There is a solution to profit-aversion – it’s called ‘trailing stop-losses’.
I talk about tools and tactics – including technical analysis and trailing stop-losses – in the next section
I’ve been trying to get to grips with some of the lingo: those random snatches of jargon that you know must be important, but haven’t got a dizzy what they mean. Only a few of them are relevant when it comes to short-term spread-bets, and here are a few of the most important ones.
Long or short?
This is the fundamental tactic: buy or sell? Go long or short? Going long is when you buy shares with the expectation that the price will rise; going short is when you sell shares with the expectation that the price will fall (how do you sell something you don’t already own? I really don’t know, but we don’t need to worry about that!).
Share prices will often fall on the first day of a new week, even when you’ve been optimistic enough to bet on a rise. Try not to chicken out, sell-up and switch your bet – if you’re logic was sound when you first placed the bet, this could turn into a failed move as the week progresses.
Technical analysis is the use of trends to determine the likely direction of a share’s price. Try not to pay too much attention to these – we’re focusing on reactive decision-making, responding to the here-and-now, not long-term trends. Having said that, it can be worth keeping an eye on the trends as they can inform how a company’s share price is likely to react to market events.
One of the most popular indicators of the health of a company’s shares is the Relative Strength Index (RSI). This uses the overall price trend to help determine whether a share’s price is likely to bottom-out soon or about to reach its peak and take a downward turn.
There are a number of other tools that you can use (Moving Average Convergence Divergence (MACD) is another favourite!), and many of these can now be applied from directly within the most popular trading platforms.
Trailing stop-losses are awesome. As has been said, stop losses limit risk by putting a cap on the amount that you can lose. But what if you’re flying into profit, and then things take a lengthy downward turn? You’ll stand to lose everything you were about to make, that’s what! Trailing stop losses prevent this from happening – the idea is to keep your stop loss relevant to your equity (your original investment + profit) by updating it as your profits increase. So, for example, if I invest £100 with a stop loss of £10, when the share price increases and I’m £10 in profit I update my stop loss to break-even, then when my profit reaches £20 I update it to £10. Now I’m guaranteed a profit regardless of whether the share price rises or falls. As the price rises I update my stop loss, if it falls I keep it where it’s at.
So I think I’ve got my strategy nailed. I tested a few things out this week and they seemed to pay dividends. It’s time to make the objectives clear and lay out exactly how I’m going to achieve them…
Who to bet on…
At the end of the day, this is the crux of it all: who should you bet your money on. Everything that follows is about limiting the risk for when things go wrong, while maximising the returns for when they go right. But before all of that you need to figure out where the money is and decide where to place your bets.
Sometimes this will be easy, the stakes high, the risk low; but sometimes the outcome will be less assured. Just always remember: you’re trying to decide whether the price of a share will go up or down. If it’s gonna go up, you buy; if it’s gonna go down, you sell. At the end of the day it’s a 50-50 call, but you’ve an important advantage: you’re an investor now. You’re a stakeholder in that company. Take a look at the latest company news and ask yourself: what would you do? So, what will you do? Buy or sell?
The easiest indicators of whether a share’s price is going to rise or fall is a declaration of profit and loss. Companies have to declare the status of their accounts at least once a year – the larger ones declare their profits or losses quarter-by-quarter. In the lead up to each of these declarations, financial commentators make their predictions for what they think is likely to happen. If a declaration of profit is expected, it would be wise to bet on that company by placing a buy order on their shares. The key is to place your bet before the declaration is made – that’s where the risk comes in. Until the company’s declared their accounts you can’t know for certain which way things are going to go, if you buy shares in the company with the expectation of profits being declared, you’ll likely stand to lose money if the company instead declares a loss.
But there are always indications of which way things are likely to go. You can often determine how well a company is fairing by looking at the status of their resources. Every organisation relies on the readiness of its resources, every company plays to the tune of supply and demand.
Let’s say you’re looking at a company that sells umbrellas; it’s been an unusually dry year, consumer demand has been low. It would be fair to predict a fall in profits and a drop in the price of the company’s shares. Then again, if the company had taken advantage of the sunshine to run a marketing campaign about how their umbrellas make great parasols, things may be somewhat harder to predict. You should try to limit yourself to the more reliable investments, and remember: the clearer the direction appears to be, the less the risk, the more you should be willing to invest.
Using the events calendar is one of the easiest ways to decide on which companies to invest in, but there’ll inevitably be some weeks when it’s hard to find a clear direction in which to place your money. Don’t be afraid to miss a week in your money-making schedule!
Rank your investments
Once you’ve figured out where to place your bets, you have to decide on what to place. It’s a pretty straightforward, logical process. The first step is to rank your investments in order of risk – put the ones you’re most sure of first, and least sure of last. Then you have to allocate your capital – how much you allocate to each is up to you, but you should always put more towards those you’re most confident of bringing a return.
Decide on leverage
Next you have to figure out by how much you want to leverage your capital. Leverage may seem like a wonderful thing, but it’s a dangerous tool if you don’t use it with caution. I like to keep my leverages low, as is one of my rules. But share prices vary in scale – some companies’ shares are worth less than a pound; others are worth much more. For the more expensive shares, you’ll find your money won’t go quite as far, which is when it might be a good idea to leverage it. But you should combine this thinking with your view on how likely the investment is to make a return – for high-risk investments that you’re less sure of, you should keep the leverage low regardless. As a basic outline, this is how I determine how much to leverage:
For prices under 250, leverage x2
For prices between 250 and 1000, leverage x5
For prices over 1000, leverage x10
Stop Loss and Take Profit
Your ‘stop loss’ is what prevents you from losing more than you bargained for when things take a turn for the worse. It’s important to be aware that with many trading platforms, when the share price takes a sudden turn, a stop loss can have a delay in kicking in which means that you can sometimes lose more than you planned. With this in mind, I generally set my stop loss at 10% of my investment, so for an investment of £100 I’d set it at £5. And the same goes for the ‘take profit’ – you may be willing to profit more than you are to lose, but the price of a share will only ever go so far in one direction before it turns.
That’s it, you’re ready, go out there, have fun, get rich. But don’t do anything stupid.
The legal bit: Past performance is not an indication of future results. Spread-betting carries a high degree of risk. Even when using protective measures to manage risk, it’s possible to lose more money than invested in each trade.
This article has been written to help you learn about the tools available for developing a spread-betting strategy, but does not contain, or should not be construed as containing, investment advice or an investment recommendation, or of an offer of or solicitation for any transactions in financial instruments.