Downsides and Risks

Popular or What?

Does anyone bother trading stocks anymore? I only ask, because it seems everybody is talking about CFDs. Of course they do have great advantages over regular stock trading, in that they provide leverage of your capital. But you do realize that you are not allowed to vote at the AGM, don’t you?

Your trading career may involve many contracts traded during the year, so perhaps voting rights is not high on your list of priorities. But what happens if everyone takes the same view – does this mean that companies will not be held to account for the performance of the Board of Directors? Sounds like the thin end of the wedge to me.

Revelations Will Be Customary

Thank goodness that the UK’s Financial Services Authority is on the ball. A major weakness with contracts for difference has been rectified by the decision of the FSA to bring forward disclosure of CFD positions by June of this year.

It’s been a bone of contention that the CFD can be used anonymously, but still make a profit from stock fluctuations. Some people have said that this was a gross error, but it seems that this hole has been plugged. Changes in shareholdings by directors always have to be reported, but as the CFD does not involve change of ownership it escaped this compulsion, allowing insider dealing to thrive unreported.

The only problem is that the FSA controls the disclosure of interest in UK companies – this is great as far as it goes, but does leave open the possibility of market failure in overseas companies.

The Growth of CFDs

I just read some interesting information. It seems that 30% of all London Stock exchange transactions have a contract for difference involvement. They say this is because professional investors and traders have discovered the amount of leverage available, and so choose to use CFDs rather than direct investing.

This is typical of the arrogance of professionals. They assume that they are going to make the correct selections all the time, so they are not concerned that the leverage may work against them and cause bigger losses. I know I would sooner trade my money myself, rather than commit it to professionals.

Long Term Profits

I have to admit, CFDs are not perfect. There is one situation where you should definitely consider other methods of trading.

I’m referring, of course, to the situation where you anticipate a price move, but only expect that it may occur in the next few months, without any specific date. You should not use CFDs when looking at this case. Your account will be charged interest, usually at several percent over the current bank rate, for all the time that you are holding onto that trade, and that will eat into your profits.

Getting Your Feet Wet

Everyone has to start somewhere, and if you have chosen CFDs or another leveraged product because of the lure of large profits, you need to be particularly careful. All the study in the world will not give you the feeling that you have when you place your first live trade.

No one should start trading without practicing first. Most brokers will be happy to let you open a demo account and pretend to trade, to see how you get on. It’s still very different from live trading, as your money is not at risk—but it’s the closest you can get.

Make Your Mistakes

We used to say, in the days of the rockers at Chelsea Bridge and Joe’s Café, that you’re not a true motorcyclist until you have fallen off at least three times. Much as I hate to say it, I think that trading has the same sort of need for disaster in order to improve.

We all know that you cut your losses, but I have yet to meet anyone who has been trading for a time who does not have a story about when they did not cut their losses, and lived to regret it. It’s better if you can learn after the first time, and not repeat it twice more, however!

The Most Important Thing

What’s the most important thing to concentrate on when you start trading? According to Stuart McPhee, an internationally renowned trader and speaker, it’s to make sure you don’t lose

His theory is that if you concentrate on not losing your capital, then profits will come. If you try hard to make a profit, you are more likely to fail. It makes sense in a curious way, and it’s true that if you lose your capital you are going nowhere, so it sounds like good advice

The Most Popular Derivative

Just eight years ago, CFDs were hardly known in Australia. Yet in that short time they have rapidly grown to become the most heavily traded derivative. It’s easy to see why, as they provide the flexibility and leverage which tempts traders to try it their luck

Obviously, hope is not a good trading strategy and luck may soon run out. But most CFD traders do their trading without any trading plan. Is it any wonder that so many fail?