What does ‘mean’ mean in spread betting? Is it related to ‘average’? ‘Profit’? Or does it have a different connotation? The fact is, the English language can be a bit tricky when it comes to defining abstract concepts like ‘Mean’ in particular and ‘Profit’ in general.
So let’s take a look at the English meanings of ‘Mean’ and ‘Profit’ and how they apply to spread betting.
In plain English, the average is the sum of all the individual values in the group divided by the number of items in the group. In this case, the number of items is equal to the number of shares or contracts that one owns, in other words, the denominator. The resulting value is then multiplied by the number of items in the numerator to give the average. For example, if the denominator is 3 and the numerator is 6, the average is 1.5. This calculation is easy enough to remember as ‘1.5 times 3′ which can be written as ‘1.5 x 3′ or ‘1.5 x 3 = 5 and ½’. Most people will understand what this means when they see or hear it. However, in the context of spread betting, the average can become a bit tricky to interpret. To put it simply, if you look at the average from the point of view of a long-term investor, it will appear very positive. That’s because the long-term investor is purchasing shares or contracts at a low price and then holding them for the long haul. The low price generally means that the underlying value is high which, in turn, makes the average seem very positive indeed.
On the other hand, if you are looking at the average from the perspective of a short-term trader, it will appear very negative. That’s because the short-term trader is purchasing shares or contracts at a high price and then selling them as soon as possible for a profit. In this case, the high price generally means that the average is going to be relatively low which, in turn, means that the short-term trader will suffer a substantial loss.
This one is pretty self-explanatory. Profit is, generally, what one is after in the context of investing. A profit is what remains after all costs are subtracted from revenues. In spread betting, the costs are the commission one has to pay to the bookmaker and the winnings from wagers (the revenues). In most cases, one will try to achieve a positive profit regardless of the direction of the market or the underlying value. In other words, the aim is to make a profit, regardless of whether prices go up or down. Remember, in binary options one either makes or breaks even. The same goes for spread betting. The closer one gets to breaking even, the happier the participant.
There is another key point to be made regarding profits in the context of spread betting. In most other types of investing, it is acceptable to make a loss as long as one has a realistic expectation of what that loss is going to turn into a profit. In spread betting, however, one cannot and should not make a loss, regardless of the size of the potential gain. The reason is that, in spread betting, the potential for profit is inherently limited by the number of items (shares or contracts) that one owns. If one makes a loss on an item regardless of the fact that it is a high probability of achieving a profitable outcome, the loss is never going to be offset by any other item. Sooner or later, reality is going to dawn in the form of a margin call and, subsequently, a loss. The only question is how big that loss will be.
Now we come to the tricky part. As noted earlier, in the context of investing, the average is positive because, generally, one is seeking to achieve a higher value. However, in spread betting, the average can take on a different connotation. What is it that one is trying to achieve in ‘Mean’ in spread betting? One way to look at it is in terms of a balance. To put it simply, one is trying to achieve a total amount of value, regardless of the direction of the market. Or, in other words, one is trying to make the market level-chested. To give some practical examples, if one is aiming for an average of €100,000 over the next five years, one would set the stop loss at €98,000 and the target level at €102,000. In this particular case, if the share price drops to €98,000 before the end of the month, one will suffer a severe loss. However, if the price stays above €102,000 for the rest of the month, one will make a profit of €2,000. Of course, this is a very simplified example but it highlights the point. In general, in the context of spread betting, the average is going to be positive but the end result will depend on the perspective that one takes. For example, if one is looking at the market from the perspective of a short-term trader, the average will appear very negative because that is generally what one is after. However, if one is looking at it long-term, the average will appear very positive indeed.
How Do I Calculate The Risk Of A Position?
When investing in stocks and shares, it is easy enough to work out the risk of the position. One simply takes the overall volatility of the market and multiplies it by the number of stocks or shares owned. However, in the case of spread betting, this is not so easy. Typically, in spread betting, the risk is taken directly on the margin. That is, one is risking the amount of money that one has in one’s account on each individual trade. So, in order to calculate the risk of a position, one first calculates the overall volatility of the market. To give some examples, if the market has remained relatively stable over the past month, one could safely assume that the volatility of the market is low. Therefore, on a trade where the spread is 0.5 pips, the risk is minimal. On the other hand, if the market has been extremely volatile, one could make a case that the overall volatility is high enough to justify a greater risk on the part of the trader. For example, if the market is up five months in a row and one’s stop loss is set at €10, the risk is considerable enough to warrant that level of caution. Naturally, one could avoid taking on too much risk by setting a limit on the overall amount of capital that one is prepared to lose on any one trade. In situations like this, the use of stop loss orders becomes highly advisable. In plain English, a stop loss order is an instruction given to a broker or bank to automatically sell a stock or contract at a predetermined price, generally, the market price, if the instrument reaches that price or level, before the end of the day. Using stop loss orders in spread betting is extremely beneficial for long-term investors who are purchasing shares or contracts at a low price and are, therefore, assuming a large potential for gain. For short-term traders, on the other hand, stop loss orders can be extremely detrimental because, generally, one is seeking to take advantage of short-term price movements, avoiding large losses as much as possible. Naturally, this is not to say that stop loss orders always have to be avoided. Situations where setting a stop loss order is not advisable include those where one is placing a bet on the direction of the market (i.e, going against the grain). In those situations, the use of a trailing stop loss is advised. This is where one sets a stop loss order at a price that is, generally, 20 pips below the price at which one is placing the bet and then adjust it every time one updates the position.