As a full time trader myself, I am always looking for new and creative ways to trade, but always with an eye on risk. Whilst I do open positions which are purely long or short, much of my trading is based on hedging my risk where possible. Obviously with $inary bettingr risk is known and limited in advance, and in addition one can of course exit any positions early, either to reduce a loss further, or to take a profit early. In spread betting, our profits and losses are unlimited, and whilst one can of course trade with stop losses and trailing stops, in volatile or consolidating markets, stops can and do get taken out frequently, which can be extremely frustrating especially if the markets eventually move as you forecast. This is one of the reasons I like to hedge wherever possible, and whilst profits are reduced, the time the trade is left in position is greatly extended, reducing the emotional stress of trading, and allowing profits to run longer whilst hedging losses accordingly.
Spread betting provides an ideal set of tools and techniques which which to hedge market positions, and below are one or two of my favourite strategies. If you would like to learn more about correlation and more complicated spread betting strategies, then simply follow the link here.
Pairs Trade – Two Indices
This is a trade set up that I use frequently, due to the fact that the indices in general correlate positively with one another, with my favourite indices being the FTSE 100 and Wall Street. As an example I used this trade recently when the Dow was trading at around 10,000 and the FTSE 100 at the 5,000 level, making the maths very easy for a simpleton like me! The key to any hedging strategy in spread betting is twofold. First the trade must be balanced to ensure that any move in one is comparable to a move in the other. This can get more complicated when we are cross hedging in different markets, on different instruments with different rates and possibly different unit quotes from the spread betting companies, so these are a little more complex and I cover them in detail on the above site. Second, the trade must be balanced in terms of the financial profit or loss generated by moves in each market. In this example we can see from the maths that a 1 point move in the FTSE is roughly equivalent to a two point move in Wall Street. Having analysed the charts my view was that the FTSE100 was due for a rise and I therefore bought two contracts on this index at £5 and sold one contract on Wall Street at £10. Several days later I closed out both trades for a small profit after a short rally in equities and a gap opening between the indices.
If we analyse this trade, there are several points to note. First, compare the stress level of £10 per point on the FTSE 100 ‘naked’ – a hundred point move would be + or – £1,000 – to be honest I’m not sure which is worse – sitting on £1,000 paper profit, or -£1,000 paper loss. Of course in the later case we would be trading on hope that the market turns and we recover our ‘loss’. Such are the emotions of trading that we all have to live with each day, which is why my own trading philosophy, whatever the market or the instrument, is to hedge wherever possible. Secondly, it is important to realise that in any hedge strategy, if the instruments being traded correlate positively, then we must be long in one position, and short in the other, otherwise we are doubling our position! For inverse correlation we trade in the same direction. Finally, we could of course have weighted our hedge above, by small amounts, trading perhaps at 1.2 to 1 or even 1.5 to 1 if we are very confident. The possibilities are endless with spread betting, and provided you do your homework, research the markets, hedge, and trade in small size, you should make profits longer term.
Arbitrage
Arbitrage, or arbing as it is sometimes called, can and does happen, but tends to occur more in the sports and political fields where spreads are based more on the views of individuals within the companies concerned, whereas in the financial world prices are based on the underlying derivatives and markets. However, arbitrage can and does happen but you have to be quick and have several accounts with different companies. It is not a strategy that can be used longer term by the retail trader, although it is one that is used in the professional world, where tiny differential quotes between time zones and markets across the world provide opportunities for instant trades to profit from these differentials. In financial spread betting this is limited to exotic currencies from time to time. An arbitrage occurs when two spread betting companies quote a spread which does not overlap. Suppose for example one company is offering a spread of 1.1245 – 1.1248 on one currency, and a second spread betting firm is offering 1.1250 – 1.1253. The gap between a buy bet with the first company and a sell bet with the second is 2 pips ( 1.1248 -1.1250 ) and provided you are quick enough to spot the gap, and place a bet with each company at that spread, then you are guaranteed a profit of 2 pips when the bet expires, no matter what happens in the market. The problems are of course that first you have to have an account with both companies, second you have to be quick, and third by the time you place the bet you hope the quotes haven’t moved! They do appear occasionally, but only once in a while, so my advice is to concentrate on strategies that work, and just be aware of this one, just in case!