The importance of the spread.

The following is from our Skype ‘live’ trading room chats. Includes: know when to trade and when not; sometimes a trade is too close to call; being stopped out is part of trading, accept it; and two book recommendations.

(Buzz) A case of not only knowing when to trade but knowing when NOT to.
The following trade looked okay. But the context was poor (double bottom 6-hours prior not shown) and again news about to be released. I also didn’t like the seven pip distance to a first stop option.

Know when not to trade.

(Buzz) It’s interesting how if I take a higher entry I’m reluctant to accept as easily a worse price even though it’s a better entry?

(James) I agree. The money isn’t yours until it’s cashed out of the trade. But it doesn’t seem that way when you’ve been 10 pips in profit.

(Buzz) If I hadn’t have taken the failed higher entry, I’d not have thought twice about the short at 7:45.
I’d probably have been entered at the 7:35 bar.
However, the 7:40 bar gave a hint of a reversal. If the 7:40 had closed as a stronger bull, it would have produced a trend break buy.
All in all, some just get missed or are best left.

Sometimes it’s too close to call, best left.

(James) It quite often puts it on a knife edge before it takes off. That was another example.

(Buzz) Took what I thought was a pbc (Pattern break combi). I was way too early. Got to work on the harmony of my takes—a 90-minute hold. Aimed for ten pips but took it off at nine pips profit. Three down and tailless bear close. At that time of night, I couldn’t face another pullback — still, nine pips to balance up some earlier losses.

The upper ellipse marks a high that came within a pip or so of the stop.

(James) Well done holding for that long! Especially at that time of night.

(Buzz) Started reading this, (below) good info so far.

Published 2008, but good insight into dealers.

(Buzz) An interesting point from the book I mentioned earlier, Take each 4-hour session and calculate the pivot point. It’s a guide. Above the pivot point for the follow-on session is only longs and below the pivot point just short. Here’s an example.

Example of how to calculate ‘pivot points’.

(James) Good point, these pivot points are critical.

(Buzz) A good price action trader can look at the chart and know where the pivot point is. The calculation, however, provides some confirmation.

Took the 11 pips profit at the close of the extension bar. But a continuation is on the cards.
Known as a ‘wedge’ which is often followed by a reversal.

(Buzz) In answer to a question. Reference Alan’s question about MT4. Designed specifically for FX. He needs to watch for the spread offered on MT4 as sometimes higher than a broker’s charts. I prefer MT4 to anything else I’ve tried except ProRealtime.

Another book recommendation.

(James) Haha nice hair doo! Good opening para.

(Buzz) Yes, ignore the 1980’s style; a classic and still very much relevant.

(Buzz) About MT4 and the spread that we talked about yesterday and Alan’s question; this is a footnote from the ‘dealers’ book. Spreads were much higher back in 2008. But the principle remains.

The importance of the spread.

Margin to increase for retail traders

Our broker has granted us professional client status.

To be classified as a professional client the qualification is 2 out of the following three statements below:

  1. Carried out CFD, spread betting or forex, in significant size, at an average frequency of 10 per quarter over the previous four quarters
  2. An investment portfolio (including cash deposits and financial instruments) exceeding €500,000
  3. Work or have worked in the financial sector for at least one year in a professional position, which requires knowledge of CFDs, spread betting or forex

Why is professional client status a big deal? Because margin requirements will increase substantially for ‘retail traders’; for professional clients they will not.

What is ‘margin’?

  • It is a good faith deposit that a trader puts up for collateral to hold open a position.
  • It is not a transaction cost, but a portion of our account equity set aside and allocated as a margin deposit.
  • Trade size determines the amount of margin needed to hold open a position. As trade size increases, margin requirement increases.

This has no effect, however, on our usual spread payment: which we consider as a true identification of a retail trader. If we pay a standard spread then by definition we are retail traders.

Institutional proprietary traders (or ‘prop’ traders as they are known) trade the firm’s money (not clients money) and often at a reduced spread cost or no cost at all. They are, to our mind, non-retail traders.

But to be considered a professional client, and thereby maintain a desirable margin commitment, is excellent.

Financial spread betting

For my day trading, I use a financial spread betting company.

Don’t get bothered by the word ‘betting’; it could quite easily be called financial spread trading. However, putting the ‘betting’ word in there qualifies for no tax (under the current rules).

My opinion on why no CGT, stamp duty or explicit trading commissions:

  • It is well-known that most (and I mean most) people lose at financial spread betting. It’s not the spread betting that people fail at per se, it’s trading in general and particularly day-trading.
  • Therefore, if financial spread betting had a tax, then the vast majority would be claiming tax offsets for their losses.
  • Spread betting companies, on the other hand, make money (they operate like the casino) and the government is better off leaving the pundit who is attracted to and enjoying tax-free trading (losses) and taxing the profitable companies.

Financial spread betting is a derivative based trading which merely means that we don’t own the physical product; this does give us the advantage (not necessarily always an advantage) of being able to buy, go long, or sell, go short.

We also, unlike an ISA trade, don’t pay a fee for our trades. (I’m considering short-term trades from a DFT here). However, we do pay a spread. A spread being the difference between the buy and the sell.

It might be noticed in my ‘algorithm to trade by’ page that I make repeated reference to the spread – in particular, half-spread. The beginner doesn’t fully appreciate the importance of managing the spread. Furthermore, both the beginner and the intermediate, mainly if the latter drops into the dip, don’t fully understand the importance of managing margin and leverage.

Spread:

  • On selecting a spread betting company probably my most significant criteria is the tightness of the spread.
  • A spread of, say, 2.5 pips for GBP/JPY is not a lot when we are trading at the minimum of £1 per pip. (As an aside, the amount per trade or reward/risk measurement has a consistent potential loss per trade).
  • If we entered a trade and exited immediately then for the £1 per pip example this would cost us £2.5.
  • Okay, that sounds very reasonable mainly as the average ISA has an ‘in/out’ trade cost of £24. (An ISA also has a spread, but let’s keep it simple)
  • An expert’s (retailers) account may take them to the region of £60 per pip. An immediate ‘in/out’ in this example would cost £150. And they wouldn’t want to do that too often.
  • So, as we can see spread is a definite factor in financial spread betting; in my day-trading, I measure to 0.1 of a pip and spread included in my measurements.

The real benefit of spread betting is leverage – for the expert at least who has learnt how to manage leverage and margin. The beginner, and often the intermediate trader, will misuse leverage (only having to commit 1% to 10% of funds to a trade). There is an enquiry ongoing to protect the inexperienced trader by a substantial reduction in leverage allowed. The effect of which will probably kill financial spread betting as an attractive trading vehicle for the expert.