Binary betters and spread betters like to throw a bit of mud at each other.

Spread betters will say that binary betters are just too small time.

While binary betters accuse spread betters of getting into the markets over their heads, with little understanding of the risks involved.

Weighing up the risks

Well, the truth is that it really doesn’t matter how you find your edge over the market – whether it’s through spread betting or a system of binary bets – provided you can maintain that edge over time.

What does matter, however, is that you understand what the risks involved in your trading are. With binary betting, those risks are very clear. In spread betting, they can be a little grey when it comes to the area of margins.

So, I figured it would be worth taking a look at how those risks are calculated …

Binary basics

With a binary bet, you know exactly how much you’re risking when you place your trade. There isn’t any grey area – either you’ll win or you’ll lose.

If you’re using the IG Index binary bets, your price for the bet is displayed in a range of 0 to 100. If the bet wins, then the price will move to 100; if it loses, it’ll move to 0. So your potential profit is the difference between the price you got in at and 100. And your potential loss is the difference between the price you got in at and 0.

Let’s say that you want to bet that the FTSE will finish up by 50 points, and you’re quoted a “buy price” for that bet of 45, and you bet £1 per point.

If your bet wins, the price will be at 100, so your profit will be £55.

If your bet loses, the price will be at 0, so your loss will be £45.

With spread betting, however, risk is calculated in a very different way …

Spread-betting basics

Let’s say that I want to trade some shares in a company called XYZ. These shares are currently trading at 216p.

As a spread better, I won’t be actually buying those shares, so I won’t have to pay the full price of the shares to gain control over them.

Instead, I want to bet £5/point on these 216p shares. With a 10% margin requirement on my trading platform, this is going to cost me just:

(216 @ £5 ) x 10% = £108

So, let’s say I’ve got £5,000 in my trading account before I place this trade. I put my £5 stake on XYZ, and I’ve still got £4,892 left to play with.

Now, if the value of those shares plummets to £0, and I was stupid enough to be trading without a stop loss, then I could find myself £1080 in the red.

However, hopefully, I’m smart enough to always trade with a stop loss to protect myself from sudden price falls.

This is the kind of margin that most spread betters understand – it’s called initial margin. However, there’s another kind of margin that can creep up on you – especially if you have lots of trades open at the same time.

This is called variation margin.

Traders can get caught out by variation margin – the creeping cost of a trade that’s going against you.

Let’s say that my XYZ shares have moved off in the wrong direction, and are now standing at 190p. So I’m sitting on a potential loss of £130 (i.e. 216 – 190 @ £5).

This £130 is going to be taken away from my available trading funds.

However, this isn’t just an extra £130 added to my bill…

Because the value of the shares has fallen, my initial margin requirement is now less.

So, the margin requirement is now (190 @ £5) x 10% = £95

Plus the variation requirement (of £130) that’s been taken away from my available funds …

… means that I have a total requirement of £225.

Which is £117 more than the initial margin I’d set aside for this trade.

So, if I don’t have that extra £117 sitting in my account, I could face a margin call from my broker – otherwise they’ll close my position on me.

Of course, if I’m staking at £5/point, and never risk more than 2% of my fund on a trade, I really should have a spare £117 in my account (and more!). However, if you’re a very active trader, with a lot of positions open at any one time, these issues can crop up.

“Intelligent” brokering

Before I finish about margin requirements, a few words about specific cases of how brokers differ from one another.

Some platforms have started using an “orders aware” margining system. This means that the margin requirement is tied in with the stop loss level.

In this way, by tightening up your auto stop, you can release funds in your trading account. Some will also require a greater margin if you increase your stop loss.

Not all platforms treat this in the same way, so don’t assume with a new broker that margin will be calculated in the same way as one you were using before.

Keeping on top of your margin can seem like an unnecessary hassle, but there are some huge advantages that come with spread betting – i.e. having the power to control large positions for only a small outlay. It means that we can use our money to its maximum capacity. Totting up your margin requirements is a relatively small price to pay for this luxury.