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06-11-2011, 09:17 AM
The Straits Times
Nov 6, 2011
CONTRACTS FOR DIFFERENCE
Win big or lose big
Investors need little capital to make big bets, but it exposes them to big risks
By Aaron Low
Sales executive Brenden Lim is a firm fan of Contracts for Difference (CFDs) despite losing over $3,500, or about half, of his funds in the past month due to the volatile stock market.
'I got caught out making the wrong bets as the market moved so fast. But I am sure I can make the money back because I don't need a lot of capital to make it back,' he said.
Indeed, the biggest reason that stock market traders look to trade CFDs is due to the powerful leverage that they offer.
Trading a CFD is like trading the stock market on steroids as the investor needs to put down only a small initial outlay which controls a much larger amount of money.
When a trader buys a CFD on a blue chip like DBS Group Holdings, he needs to put up only 10 per cent of the costs of owning the stock.
'It's great because on the regular stock market, I need to stump up $12,000 for one lot of DBS. Using CFDs I pay just $1,200,' said Mr Lim.
It is also generally cheaper to trade CFDs as traders pay just 0.2 per cent commission on the face value of the contract.
CFDs also allow traders to go 'short' positions on stocks. If a trader thinks a stock may fall, he can 'short' the stock through CFDs.
In turn, the consumer is charged a daily fee for holding on to open CFD positions. These fees are usually a tiny fraction of the overall value of the CFD but, over time, they can add up.
All these advantages mean that retail investors have an added item in their arsenal to manage their capital in the markets, said CFD provider IG Markets head of premium client management, Mr Jason Hughes.
'Basically you get to participate in the movement of a stock with very little capital. And you also get to participate in any corporate action of the company, such as dividend payouts,' he said.
But there are risks that investors should be aware of.
The first big risk is that while CFDs allow you to make big bets, leverage is a double-edged sword. You can win big, but you might also lose big.
While it may seem attractive to the small-time investor that you need only put down $300 for 1,000 shares worth $3 each, which would cost $3,000 on the market, the investor is also fully responsible for all the losses as if he actually bought 1,000 shares of the company.
For instance, if the stock moved 30 cents, or 10 per cent of the share price, the investor would have lost $300, his initial entire outlay.
The second big risk to watch out for is the CFD provider itself.
This is because CFDs are essentially contracts made between the investor and the provider.
Therefore, a trader should consider the counterparty risks involved. If the brokerage on the other side of the contract goes bust, a trader's CFD may become worthless.
Mr Hughes advises investors to do their own due dilligence of the CFD provider to check the financial health as well as the type of activities it engages in.
'At IG, we just do broking and do not dabble in other forms of trading,' he said.
Mr Hughes added that in Singapore, the Monetary Authority of Singapore requires CFD providers to segregate their clients' money in a separate account from the provider's.
Most providers here have CFD education seminars and courses to help investors understand the risks involved in the instrument.
Mr Luke Lim, head of CFDs at Phillip Securities, said that the most common mistakes by their clients are over-leveraging and insufficient money management.
So, the financial firm has a wide range of courses tackling various aspects of CFDs from the beginner level all the way up to advanced ones.
'We invest heavily on educational seminars as we want our clients to be fully aware and be educated on the benefits and risks in CFDs trading before they embark on any CFD trade,' he said.
aaronl@sph.com.sg
Nov 6, 2011
CONTRACTS FOR DIFFERENCE
Win big or lose big
Investors need little capital to make big bets, but it exposes them to big risks
By Aaron Low
Sales executive Brenden Lim is a firm fan of Contracts for Difference (CFDs) despite losing over $3,500, or about half, of his funds in the past month due to the volatile stock market.
'I got caught out making the wrong bets as the market moved so fast. But I am sure I can make the money back because I don't need a lot of capital to make it back,' he said.
Indeed, the biggest reason that stock market traders look to trade CFDs is due to the powerful leverage that they offer.
Trading a CFD is like trading the stock market on steroids as the investor needs to put down only a small initial outlay which controls a much larger amount of money.
When a trader buys a CFD on a blue chip like DBS Group Holdings, he needs to put up only 10 per cent of the costs of owning the stock.
'It's great because on the regular stock market, I need to stump up $12,000 for one lot of DBS. Using CFDs I pay just $1,200,' said Mr Lim.
It is also generally cheaper to trade CFDs as traders pay just 0.2 per cent commission on the face value of the contract.
CFDs also allow traders to go 'short' positions on stocks. If a trader thinks a stock may fall, he can 'short' the stock through CFDs.
In turn, the consumer is charged a daily fee for holding on to open CFD positions. These fees are usually a tiny fraction of the overall value of the CFD but, over time, they can add up.
All these advantages mean that retail investors have an added item in their arsenal to manage their capital in the markets, said CFD provider IG Markets head of premium client management, Mr Jason Hughes.
'Basically you get to participate in the movement of a stock with very little capital. And you also get to participate in any corporate action of the company, such as dividend payouts,' he said.
But there are risks that investors should be aware of.
The first big risk is that while CFDs allow you to make big bets, leverage is a double-edged sword. You can win big, but you might also lose big.
While it may seem attractive to the small-time investor that you need only put down $300 for 1,000 shares worth $3 each, which would cost $3,000 on the market, the investor is also fully responsible for all the losses as if he actually bought 1,000 shares of the company.
For instance, if the stock moved 30 cents, or 10 per cent of the share price, the investor would have lost $300, his initial entire outlay.
The second big risk to watch out for is the CFD provider itself.
This is because CFDs are essentially contracts made between the investor and the provider.
Therefore, a trader should consider the counterparty risks involved. If the brokerage on the other side of the contract goes bust, a trader's CFD may become worthless.
Mr Hughes advises investors to do their own due dilligence of the CFD provider to check the financial health as well as the type of activities it engages in.
'At IG, we just do broking and do not dabble in other forms of trading,' he said.
Mr Hughes added that in Singapore, the Monetary Authority of Singapore requires CFD providers to segregate their clients' money in a separate account from the provider's.
Most providers here have CFD education seminars and courses to help investors understand the risks involved in the instrument.
Mr Luke Lim, head of CFDs at Phillip Securities, said that the most common mistakes by their clients are over-leveraging and insufficient money management.
So, the financial firm has a wide range of courses tackling various aspects of CFDs from the beginner level all the way up to advanced ones.
'We invest heavily on educational seminars as we want our clients to be fully aware and be educated on the benefits and risks in CFDs trading before they embark on any CFD trade,' he said.
aaronl@sph.com.sg
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/